Nepal Financial Reporting Standard 9 Financial … NFRS 9...NFRS 9 Nepal Financial Reporting...

NFRS 9

Nepal Financial Reporting Standard 9Financial Instruments

Chapter 1 Objective

1.1 The objective of this Standard is to establish principles for the financial reporting of

financial assets and financial liabilities that will present relevant and useful

information to users of financial statements for their assessment of the amounts,

timing and uncertainty of an entity’s future cash flows.

Chapter 2 Scope

2.1 This Standard shall be applied by all entities to all types of financial instruments

except:

(a) those interests in subsidiaries, associates and joint ventures that are

accounted for in accordance with NFRS 10 Consolidated Financial

Statements, N A S 2 7 Separate Financial Statements or NAS 28

Investments in Associates and Joint Ventures. However, in some cases,

NFRS 10, NAS 27 or NAS 28 require or permit an entity to account for

an interest in a subsidiary, associate or joint venture in accordance with

some or all of the requirements of this Standard. Entities shall also apply

this Standard to derivatives on an interest in a subsidiary, associate or

joint venture unless the derivative meets the definition of an equity

instrument of the entity in NAS 32 Financial Instruments: Presentation.

(b) rights and obligations under leases to which NFRS 16 Leases applies.

However:

(i) finance lease receivables (ie net investments in finance leases)

and operating lease receivables recognised by a lessor are subject

to the derecognition and impairment requirements of this

Standard;

(ii) lease liabilities recognised by a lessee are subject to the

derecognition requirements in paragraph 3.3.1 of this Standard;

and

(iii) derivatives that are embedded in leases are subject to the

embedded derivatives requirements of this Standard.

(c) employers’ rights and obligations under employee benefit plans, to which

NAS 19 Employee Benefits applies.

(d) financial instruments issued by the entity that meet the definition of an

equity instrument in NAS 32 (including options and warrants) or that

are required to be classified as an equity instrument in accordance with

paragraphs 16A and 16B or paragraphs 16C and 16D of NAS 32.

However, the holder of such equity instruments shall apply this Standard

to those instruments, unless they meet the exception in (a).

(e) rights and obligations arising under a contract within the scope of NFRS

1 7 Insurance Contracts, other than an issuer’s rights and obligations

arising under an insurance contract that meets the definition of a

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financial guarantee contract. However, this Standard applies to (i) a

derivative that is embedded in a contract within the scope of NFRS 17, if

the derivative is not itself a contract within the scope of NFRS 17; and

(ii) an investment component that is separated from a contract within

the scope of NFRS 17, if NFRS 17 requires such separation. Moreover, if

an issuer of financial guarantee contracts has previously asserted

explicitly that it regards such contracts as insurance contracts and has

used accounting that is applicable to insurance contracts, the issuer may

elect to apply either this Standard or NFRS 17 to such financial

guarantee contracts (see paragraphs B2.5–B2.6). The issuer may make

that election contract by contract, but the election for each contract is

irrevocable.

(f) any forward contract between an acquirer and a selling shareholder to

buy or sell an acquiree that will result in a business combination within

the scope of NFRS 3 Business Combinations at a future acquisition date.

The term of the forward contract should not exceed a reasonable period

normally necessary to obtain any required approvals and to complete

the transaction.

(g) loan commitments other than those loan commitments described in

paragraph 2.3. However, an issuer of loan commitments shall apply the

impairment requirements of this Standard to loan commitments that are

not otherwise within the scope of this Standard. Also, all loan

commitments are subject to the derecognition requirements of this

Standard.

(h) financial instruments, contracts and obligations under share-based

payment transactions to which NFRS 2 Share-based Payment applies,

except for contracts within the scope of paragraphs 2.4–2.7 of this

Standard to which this Standard applies.

(i) rights to payments to reimburse the entity for expenditure that it is

required to make to settle a liability that it recognises as a provision in

accordance with NAS 37 Provisions, Contingent Liabilities and

Contingent Assets, or for which, in an earlier period, it recognised a

provision in accordance with NAS 37.

(j) rights and obligations within the scope of NFRS 15 Revenue from

Contracts with Customers that are financial instruments, except for those

that NFRS 15 specifies are accounted for in accordance with this

Standard.

2.2 The impairment requirements of this Standard shall be applied to those rights

that NFRS 15 specifies are accounted for in accordance with this Standard for

the purposes of recognising impairment gains or losses.

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2.3 The following loan commitments are within the scope of this Standard:

(a) loan commitments that the entity designates as financial liabilities at fair

value through profit or loss (see paragraph 4.2.2). An entity that has a

past practice of selling the assets resulting from its loan commitments

shortly after origination shall apply this Standard to all its loan

commitments in the same class.

(b) loan commitments that can be settled net in cash or by delivering or

issuing another financial instrument. These loan commitments are

derivatives. A loan commitment is not regarded as settled net merely

because the loan is paid out in instalments (for example, a mortgage

construction loan that is paid out in instalments in line with the progress

of construction).

(c) commitments to provide a loan at a below-market interest rate (see

paragraph 4.2.1(d)).

2.4 This Standard shall be applied to those contracts to buy or sell a non-financial

item that can be settled net in cash or another financial instrument, or by

exchanging financial instruments, as if the contracts were financial instruments,

with the exception of contracts that were entered into and continue to be held

for the purpose of the receipt or delivery of a non-financial item in accordance

with the entity’s expected purchase, sale or usage requirements. However, this

Standard shall be applied to those contracts that an entity designates as

measured at fair value through profit or loss in accordance with paragraph 2.5.

2.5 A contract to buy or sell a non-financial item that can be settled net in cash or

another financial instrument, or by exchanging financial instruments, as if the

contract was a financial instrument, may be irrevocably designated as measured

at fair value through profit or loss even if it was entered into for the purpose of

the receipt or delivery of a non-financial item in accordance with the entity’s

expected purchase, sale or usage requirements. This designation is available only

at inception of the contract and only if it eliminates or significantly reduces a

recognition inconsistency (sometimes referred to as an ‘accounting mismatch’)

that would otherwise arise from not recognising that contract because it is

excluded from the scope of this Standard (see paragraph 2.4).

2.6 There are various ways in which a contract to buy or sell a non-financial item can be

settled net in cash or another financial instrument or by exchanging financial

instruments. These include:

(a) when the terms of the contract permit either party to settle it net in cash or

another financial instrument or by exchanging financial instruments;

(b) when the ability to settle net in cash or another financial instrument, or by

exchanging financial instruments, is not explicit in the terms of the contract,

but the entity has a practice of settling similar contracts net in cash or another

financial instrument or by exchanging financial instruments (whether with

the counterparty, by entering into offsetting contracts or by selling the

contract before its exercise or lapse);

(c) when, for similar contracts, the entity has a practice of taking delivery of the

underlying and selling it within a short period after delivery for the purpose

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of generating a profit from short-term fluctuations in price or dealer’s

margin; and

(d) when the non-financial item that is the subject of the contract is readily

convertible to cash.

A contract to which (b) or (c) applies is not entered into for the purpose of the receipt

or delivery of the non-financial item in accordance with the entity’s expected

purchase, sale or usage requirements and, accordingly, is within the scope of this

Standard. Other contracts to which paragraph 2.4 applies are evaluated to determine

whether they were entered into and continue to be held for the purpose of the receipt

or delivery of the non-financial item in accordance with the entity’s expected

purchase, sale or usage requirements and, accordingly, whether they are within the

scope of this Standard.

2.7 A written option to buy or sell a non-financial item that can be settled net in cash or

another financial instrument, or by exchanging financial instruments, in accordance

with paragraph 2.6(a) or 2.6(d) is within the scope of this Standard. Such a contract

cannot be entered into for the purpose of the receipt or delivery of the non-financial

item in accordance with the entity’s expected purchase, sale or usage requirements.

Chapter 3 Recognition and derecognition

3.1 Initial recognition

3.1.1 An entity shall recognise a financial asset or a financial liability in its statement

of financial position when, and only when, the entity becomes party to the

contractual provisions of the instrument (see paragraphs B3.1.1 and B3.1.2).

When an entity first recognises a financial asset, it shall classify it in accordance

with paragraphs 4.1.1–4.1.5 and measure it in accordance with paragraphs

5.1.1–5.1.3. When an entity first recognises a financial liability, it shall classify it

in accordance with paragraphs 4.2.1 and 4.2.2 and measure it in accordance

with paragraph 5.1.1.

Regular way purchase or sale of financial assets

3.1.2 A regular way purchase or sale of financial assets shall be recognised and

derecognised, as applicable, using trade date accounting or settlement date

accounting (see paragraphs B3.1.3–B3.1.6).

3.2 Derecognition of financial assets

3.2.1 In consolidated financial statements, paragraphs 3.2.2–3.2.9, B3.1.1, B3.1.2 and

B3.2.1–B3.2.17 are applied at a consolidated level. Hence, an entity first consolidates

all subsidiaries in accordance with NFRS 10 and then applies those paragraphs to the

resulting group.

3.2.2 Before evaluating whether, and to what extent, derecognition is appropriate

under paragraphs 3.2.3–3.2.9, an entity determines whether those paragraphs

should be applied to a part of a financial asset (or a part of a group of similar

financial assets) or a financial asset (or a group of similar financial assets) in its

entirety, as follows.

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(a) Paragraphs 3.2.3–3.2.9 are applied to a part of a financial asset (or a

part of a group of similar financial assets) if, and only if, the part being

considered for derecognition meets one of the following three conditions.

(i) The part comprises only specifically identified cash flows from a

financial asset (or a group of similar financial assets). For

example, when an entity enters into an interest rate strip

whereby the counterparty obtains the right to the interest cash

flows, but not the principal cash flows from a debt instrument,

paragraphs 3.2.3–3.2.9 are applied to the interest cash flows.

(ii) The part comprises only a fully proportionate (pro rata) share of

the cash flows from a financial asset (or a group of similar

financial assets). For example, when an entity enters into an

arrangement whereby the counterparty obtains the rights to a 90

per cent share of all cash flows of a debt instrument, paragraphs

3.2.3–3.2.9 are applied to 90 per cent of those cash flows. If there

is more than one counterparty, each counterparty is not required

to have a proportionate share of the cash flows provided that the

transferring entity has a fully proportionate share.

(iii) The part comprises only a fully proportionate (pro rata) share of

specifically identified cash flows from a financial asset (or a

group of similar financial assets). For example, when an entity

enters into an arrangement whereby the counterparty obtains

the rights to a 90 per cent share of interest cash flows from a

financial asset, paragraphs 3.2.3–3.2.9 are applied to 90 per cent

of those interest cash flows. If there is more than one

counterparty, each counterparty is not required to have a

proportionate share of the specifically identified cash flows

provided that the transferring entity has a fully proportionate

share.

(b) In all other cases, paragraphs 3.2.3–3.2.9 are applied to the financial

asset in its entirety (or to the group of similar financial assets in their

entirety). For example, when an entity transfers (i) the rights to the first

or the last 90 per cent of cash collections from a financial asset (or a

group of financial assets), or (ii) the rights to 90 per cent of the cash

flows from a group of receivables, but provides a guarantee to

compensate the buyer for any credit losses up to 8 per cent of the

principal amount of the receivables, paragraphs 3.2.3–3.2.9 are applied

to the financial asset (or a group of similar financial assets) in its

entirety.

In paragraphs 3.2.3–3.2.12, the term ‘financial asset’ refers to either a part of a

financial asset (or a part of a group of similar financial assets) as identified in (a)

above or, otherwise, a financial asset (or a group of similar financial assets) in its

entirety.

3.2.3 An entity shall derecognise a financial asset when, and only when:

(a) the contractual rights to the cash flows from the financial asset expire, or

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(b) it transfers the financial asset as set out in paragraphs 3.2.4 and 3.2.5

and the transfer qualifies for derecognition in accordance with

paragraph 3.2.6.

(See paragraph 3.1.2 for regular way sales of financial assets.)

3.2.4 An entity transfers a financial asset if, and only if, it either:

(a) transfers the contractual rights to receive the cash flows of the financial

asset, or

(b) retains the contractual rights to receive the cash flows of the financial

asset, but assumes a contractual obligation to pay the cash flows to one

or more recipients in an arrangement that meets the conditions in

paragraph 3.2.5.

3.2.5 When an entity retains the contractual rights to receive the cash flows of a

financial asset (the ‘original asset’), but assumes a contractual obligation to pay

those cash flows to one or more entities (the ‘eventual recipients’), the entity

treats the transaction as a transfer of a financial asset if, and only if, all of the

following three conditions are met.

(a) The entity has no obligation to pay amounts to the eventual recipients

unless it collects equivalent amounts from the original asset. Short-term

advances by the entity with the right of full recovery of the amount lent

plus accrued interest at market rates do not violate this condition.

(b) The entity is prohibited by the terms of the transfer contract from selling

or pledging the original asset other than as security to the eventual

recipients for the obligation to pay them cash flows.

(c) The entity has an obligation to remit any cash flows it collects on behalf

of the eventual recipients without material delay. In addition, the entity

is not entitled to reinvest such cash flows, except for investments in cash

or cash equivalents (as defined in NAS 7 Statement of Cash Flows)

during the short settlement period from the collection date to the date of

required remittance to the eventual recipients, and interest earned on

such investments is passed to the eventual recipients.

3.2.6 When an entity transfers a financial asset (see paragraph 3.2.4), it shall evaluate

the extent to which it retains the risks and rewards of ownership of the financial

asset. In this case:

(a) if the entity transfers substantially all the risks and rewards of

ownership of the financial asset, the entity shall derecognise the financial

asset and recognise separately as assets or liabilities any rights and

obligations created or retained in the transfer.

(b) if the entity retains substantially all the risks and rewards of ownership

of the financial asset, the entity shall continue to recognise the financial

asset.

(c) if the entity neither transfers nor retains substantially all the risks and

rewards of ownership of the financial asset, the entity shall determine

whether it has retained control of the financial asset. In this case:

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(i) if the entity has not retained control, it shall derecognise the

financial asset and recognise separately as assets or liabilities any

rights and obligations created or retained in the transfer.

(ii) if the entity has retained control, it shall continue to recognise

the financial asset to the extent of its continuing involvement in

the financial asset (see paragraph 3.2.16).

3.2.7 The transfer of risks and rewards (see paragraph 3.2.6) is evaluated by comparing the

entity’s exposure, before and after the transfer, with the variability in the amounts and

timing of the net cash flows of the transferred asset. An entity has retained

substantially all the risks and rewards of ownership of a financial asset if its exposure

to the variability in the present value of the future net cash flows from the financial

asset does not change significantly as a result of the transfer (eg because the entity

has sold a financial asset subject to an agreement to buy it back at a fixed price or the

sale price plus a lender’s return). An entity has transferred substantially all the risks

and rewards of ownership of a financial asset if its exposure to such variability is no

longer significant in relation to the total variability in the present value of the future

net cash flows associated with the financial asset (eg because the entity has sold a

financial asset subject only to an option to buy it back at its fair value at the time of

repurchase or has transferred a fully proportionate share of the cash flows from a

larger financial asset in an arrangement, such as a loan sub-participation, that meets

the conditions in paragraph 3.2.5).

3.2.8 Often it will be obvious whether the entity has transferred or retained substantially all

risks and rewards of ownership and there will be no need to perform any

computations. In other cases, it will be necessary to compute and compare the

entity’s exposure to the variability in the present value of the future net cash flows

before and after the transfer. The computation and comparison are made using as the

discount rate an appropriate current market interest rate. All reasonably possible

variability in net cash flows is considered, with greater weight being given to those

outcomes that are more likely to occur.

3.2.9 Whether the entity has retained control (see paragraph 3.2.6(c)) of the transferred

asset depends on the transferee’s ability to sell the asset. If the transferee has the

practical ability to sell the asset in its entirety to an unrelated third party and is able to

exercise that ability unilaterally and without needing to impose additional restrictions

on the transfer, the entity has not retained control. In all other cases, the entity has

retained control.

Transfers that qualify for derecognition

3.2.10 If an entity transfers a financial asset in a transfer that qualifies for

derecognition in its entirety and retains the right to service the financial asset for

a fee, it shall recognise either a servicing asset or a servicing liability for that

servicing contract. If the fee to be received is not expected to compensate the

entity adequately for performing the servicing, a servicing liability for the

servicing obligation shall be recognised at its fair value. If the fee to be received

is expected to be more than adequate compensation for the servicing, a servicing

asset shall be recognised for the servicing right at an amount determined on the

basis of an allocation of the carrying amount of the larger financial asset in

accordance with paragraph 3.2.13.

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3.2.11 If, as a result of a transfer, a financial asset is derecognised in its entirety but the

transfer results in the entity obtaining a new financial asset or assuming a new

financial liability, or a servicing liability, the entity shall recognise the new

financial asset, financial liability or servicing liability at fair value.

3.2.12 On derecognition of a financial asset in its entirety, the difference between:

(a) the carrying amount (measured at the date of derecognition) and

(b) the consideration received (including any new asset obtained less any

new liability assumed)

shall be recognised in profit or loss.

3.2.13 If the transferred asset is part of a larger financial asset (eg when an entity

transfers interest cash flows that are part of a debt instrument, see paragraph

3.2.2(a)) and the part transferred qualifies for derecognition in its entirety, the

previous carrying amount of the larger financial asset shall be allocated between

the part that continues to be recognised and the part that is derecognised, on the

basis of the relative fair values of those parts on the date of the transfer. For this

purpose, a retained servicing asset shall be treated as a part that continues to be

recognised. The difference between:

(a) the carrying amount (measured at the date of derecognition) allocated to

the part derecognised and

(b) the consideration received for the part derecognised (including any new

asset obtained less any new liability assumed)


3.2.14 When an entity allocates the previous carrying amount of a larger financial asset

between the part that continues to be recognised and the part that is derecognised, the

fair value of the part that continues to be recognised needs to be measured. When the

entity has a history of selling parts similar to the part that continues to be recognised

or other market transactions exist for such parts, recent prices of actual transactions

provide the best estimate of its fair value. When there are no price quotes or recent

market transactions to support the fair value of the part that continues to be

recognised, the best estimate of the fair value is the difference between the fair value

of the larger financial asset as a whole and the consideration received from the

transferee for the part that is derecognised.

Transfers that do not qualify for derecognition

3.2.15 If a transfer does not result in derecognition because the entity has retained

substantially all the risks and rewards of ownership of the transferred asset, the

entity shall continue to recognise the transferred asset in its entirety and shall

recognise a financial liability for the consideration received. In subsequent

periods, the entity shall recognise any income on the transferred asset and any

expense incurred on the financial liability.

Continuing involvement in transferred assets

3.2.16 If an entity neither transfers nor retains substantially all the risks and rewards

of ownership of a transferred asset, and retains control of the transferred asset,

the entity continues to recognise the transferred asset to the extent of its

continuing involvement. The extent of the entity’s continuing involvement in the

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transferred asset is the extent to which it is exposed to changes in the value of

the transferred asset. For example:

(a) When the entity’s continuing involvement takes the form of

guaranteeing the transferred asset, the extent of the entity’s continuing

involvement is the lower of (i) the amount of the asset and (ii) the

maximum amount of the consideration received that the entity could be

required to repay (‘the guarantee amount’).

(b) When the entity’s continuing involvement takes the form of a written or

purchased option (or both) on the transferred asset, the extent of the

entity’s continuing involvement is the amount of the transferred asset

that the entity may repurchase. However, in the case of a written put

option on an asset that is measured at fair value, the extent of the entity’s

continuing involvement is limited to the lower of the fair value of the

transferred asset and the option exercise price (see paragraph B3.2.13).

(c) When the entity’s continuing involvement takes the form of a cash-

settled option or similar provision on the transferred asset, the extent of

the entity’s continuing involvement is measured in the same way as that

which results from non-cash settled options as set out in (b) above.

3.2.17 When an entity continues to recognise an asset to the extent of its continuing

involvement, the entity also recognises an associated liability. Despite the other

measurement requirements in this Standard, the transferred asset and the

associated liability are measured on a basis that reflects the rights and

obligations that the entity has retained. The associated liability is measured in

such a way that the net carrying amount of the transferred asset and the

associated liability is:

(a) the amortised cost of the rights and obligations retained by the entity, if

the transferred asset is measured at amortised cost, or

(b) equal to the fair value of the rights and obligations retained by the entity

when measured on a stand-alone basis, if the transferred asset is

measured at fair value.

3.2.18 The entity shall continue to recognise any income arising on the transferred

asset to the extent of its continuing involvement and shall recognise any expense

incurred on the associated liability.

3.2.19 For the purpose of subsequent measurement, recognised changes in the fair

value of the transferred asset and the associated liability are accounted for

consistently with each other in accordance with paragraph 5.7.1, and shall not

be offset.

3.2.20 If an entity’s continuing involvement is in only a part of a financial asset (eg

when an entity retains an option to repurchase part of a transferred asset, or

retains a residual interest that does not result in the retention of substantially all

the risks and rewards of ownership and the entity retains control), the entity

allocates the previous carrying amount of the financial asset between the part it

continues to recognise under continuing involvement, and the part it no longer

recognises on the basis of the relative fair values of those parts on the date of the

transfer. For this purpose, the requirements of paragraph 3.2.14 apply. The

difference between:

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(a) the carrying amount (measured at the date of derecognition) allocated to

the part that is no longer recognised and

(b) the consideration received for the part no longer recognised


3.2.21 If the transferred asset is measured at amortised cost, the option in this Standard to

designate a financial liability as at fair value through profit or loss is not applicable to

the associated liability.

All transfers

3.2.22 If a transferred asset continues to be recognised, the asset and the associated

liability shall not be offset. Similarly, the entity shall not offset any income

arising from the transferred asset with any expense incurred on the associated

liability (see paragraph 42 of NAS 32).

3.2.23 If a transferor provides non-cash collateral (such as debt or equity instruments)

to the transferee, the accounting for the collateral by the transferor and the

transferee depends on whether the transferee has the right to sell or repledge the

collateral and on whether the transferor has defaulted. The transferor and

transferee shall account for the collateral as follows:

(a) If the transferee has the right by contract or custom to sell or repledge

the collateral, then the transferor shall reclassify that asset in its

statement of financial position (eg as a loaned asset, pledged equity

instruments or repurchase receivable) separately from other assets.

(b) If the transferee sells collateral pledged to it, it shall recognise the

proceeds from the sale and a liability measured at fair value for its

obligation to return the collateral.

(c) If the transferor defaults under the terms of the contract and is no

longer entitled to redeem the collateral, it shall derecognise the

collateral, and the transferee shall recognise the collateral as its asset

initially measured at fair value or, if it has already sold the collateral,

derecognise its obligation to return the collateral.

(d) Except as provided in (c), the transferor shall continue to carry the

collateral as its asset, and the transferee shall not recognise the collateral

as an asset.

3.3 Derecognition of financial liabilities

3.3.1 An entity shall remove a financial liability (or a part of a financial liability) from

its statement of financial position when, and only when, it is extinguished—ie

when the obligation specified in the contract is discharged or cancelled or

expires.

3.3.2 An exchange between an existing borrower and lender of debt instruments with

substantially different terms shall be accounted for as an extinguishment of the

original financial liability and the recognition of a new financial liability.

Similarly, a substantial modification of the terms of an existing financial liability

or a part of it (whether or not attributable to the financial difficulty of the

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debtor) shall be accounted for as an extinguishment of the original financial

liability and the recognition of a new financial liability.

3.3.3 The difference between the carrying amount of a financial liability (or part of a

financial liability) extinguished or transferred to another party and the

consideration paid, including any non-cash assets transferred or liabilities

assumed, shall be recognised in profit or loss.

3.3.4 If an entity repurchases a part of a financial liability, the entity shall allocate the

previous carrying amount of the financial liability between the part that continues to

be recognised and the part that is derecognised based on the relative fair values of

those parts on the date of the repurchase. The difference between (a) the carrying

amount allocated to the part derecognised and (b) the consideration paid, including

any non-cash assets transferred or liabilities assumed, for the part derecognised shall

be recognised in profit or loss.

3.3.5 Some entities operate, either internally or externally, an investment fund that provides

investors with benefits determined by units in the fund and recognise financial

liabilities for the amounts to be paid to those investors. Similarly, some entities issue

groups of insurance contracts with direct participation features and those entities hold

the underlying items. Some such funds or underlying items include the entity’s

financial liability (for example, a corporate bond issued). Despite the other

requirements in this Standard for the derecognition of financial liabilities, an entity

may elect not to derecognise its financial liability that is included in such a fund or is

an underlying item when, and only when, the entity repurchases its financial liability

for such purposes. Instead, the entity may elect to continue to account for that

instrument as a financial liability and to account for the repurchased instrument as if

the instrument were a financial asset, and measure it at fair value through profit or

loss in accordance with this Standard. That election is irrevocable and made on an

instrument-by-instrument basis. For the purposes of this election, insurance contracts

include investment contracts with discretionary participation features. (See NFRS 17

for terms used in this paragraph that are defined in that Standard.)

Chapter 4 Classification

4.1 Classification of financial assets

4.1.1 Unless paragraph 4.1.5 applies, an entity shall classify financial assets as

subsequently measured at amortised cost, fair value through other

comprehensive income or fair value through profit or loss on the basis of both:

(a) the entity’s business model for managing the financial assets and

(b) the contractual cash flow characteristics of the financial asset.

4.1.2 A financial asset shall be measured at amortised cost if both of the following

conditions are met:

(a) the financial asset is held within a business model whose objective is to

hold financial assets in order to collect contractual cash flows and

(b) the contractual terms of the financial asset give rise on specified dates to

cash flows that are solely payments of principal and interest on the

principal amount outstanding.

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Paragraphs B4.1.1–B4.1.26 provide guidance on how to apply these conditions.

4.1.2A A financial asset shall be measured at fair value through other comprehensive

income if both of the following conditions are met:

(a) the financial asset is held within a business model whose objective is

achieved by both collecting contractual cash flows and selling financial

assets and

(b) the contractual terms of the financial asset give rise on specified dates to

cash flows that are solely payments of principal and interest on the


Paragraphs B4.1.1–B4.1.26 provide guidance on how to apply these conditions.

4.1.3 For the purpose of applying paragraphs 4.1.2(b) and 4.1.2A(b):

(a) principal is the fair value of the financial asset at initial recognition.

Paragraph B4.1.7B provides additional guidance on the meaning of

principal.

(b) interest consists of consideration for the time value of money, for the

credit risk associated with the principal amount outstanding during a

particular period of time and for other basic lending risks and costs, as

well as a profit margin. Paragraphs B4.1.7A and B4.1.9A–B4.1.9E

provide additional guidance on the meaning of interest, including the

meaning of the time value of money.

4.1.4 A financial asset shall be measured at fair value through profit or loss unless it is

measured at amortised cost in accordance with paragraph 4.1.2 or at fair value

through other comprehensive income in accordance with paragraph 4.1.2A.

However an entity may make an irrevocable election at initial recognition for

particular investments in equity instruments that would otherwise be measured

at fair value through profit or loss to present subsequent changes in fair value in

other comprehensive income (see paragraphs 5.7.5–5.7.6).

Option to designate a financial asset at fair value through profit or loss

4.1.5 Despite paragraphs 4.1.1–4.1.4, an entity may, at initial recognition, irrevocably

designate a financial asset as measured at fair value through profit or loss if

doing so eliminates or significantly reduces a measurement or recognition

inconsistency (sometimes referred to as an ‘accounting mismatch’) that would

otherwise arise from measuring assets or liabilities or recognising the gains and

losses on them on different bases (see paragraphs B4.1.29–B4.1.32).

4.2 Classification of financial liabilities

4.2.1 An entity shall classify all financial liabilities as subsequently measured at

amortised cost, except for:

(a) financial liabilities at fair value through profit or loss . Such liabilities,

including derivatives that are liabilities, shall be subsequently measured

at fair value.

(b) financial liabilities that arise when a transfer of a financial asset does not

qualify for derecognition or when the continuing involvement approach

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applies. Paragraphs 3.2.15 and 3.2.17 apply to the measurement of such

financial liabilities.

(c) financial guarantee contracts. After initial recognition, an issuer of such a

contract shall (unless paragraph 4.2.1(a) or (b) applies) subsequently

measure it at the higher of:

(i) the amount of the loss allowance determined in accordance with

Section 5.5 and

(ii) the amount initially recognised (see paragraph 5.1.1) less, when

appropriate, the cumulative amount of income recognised in

accordance with the principles of NFRS 15.

(d) commitments to provide a loan at a below-market interest rate. An

issuer of such a commitment shall (unless paragraph 4.2.1(a) applies)

subsequently measure it at the higher of:

(i) the amount of the loss allowance determined in accordance with

Section 5.5 and

(ii) the amount initially recognised (see paragraph 5.1.1) less, when

appropriate, the cumulative amount of income recognised in

accordance with the principles of NFRS 15.

(e) contingent consideration recognised by an acquirer in a business

combination to which NFRS 3 applies. Such contingent consideration

shall subsequently be measured at fair value with changes recognised in

profit or loss.

Option to designate a financial liability at fair value through profit or loss

4.2.2 An entity may, at initial recognition, irrevocably designate a financial liability as

measured at fair value through profit or loss when permitted by paragraph

4.3.5, or when doing so results in more relevant information, because either:

(a) it eliminates or significantly reduces a measurement or recognition

inconsistency (sometimes referred to as ‘an accounting mismatch’) that

would otherwise arise from measuring assets or liabilities or recognising

the gains and losses on them on different bases (see paragraphs B4.1.29–

B4.1.32); or

(b) a group of financial liabilities or financial assets and financial liabilities

is managed and its performance is evaluated on a fair value basis, in

accordance with a documented risk management or investment strategy,

and information about the group is provided internally on that basis to

the entity’s key management personnel (as defined in NAS 24 Related

Party Disclosures), for example, the entity’s board of directors and chief

executive officer (see paragraphs B4.1.33–B4.1.36).

4.3 Embedded derivatives

4.3.1 An embedded derivative is a component of a hybrid contract that also includes a non-

derivative host—with the effect that some of the cash flows of the combined

instrument vary in a way similar to a stand-alone derivative. An embedded derivative

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causes some or all of the cash flows that otherwise would be required by the contract

to be modified according to a specified interest rate, financial instrument price,

commodity price, foreign exchange rate, index of prices or rates, credit rating or

credit index, or other variable, provided in the case of a non-financial variable that

the variable is not specific to a party to the contract. A derivative that is attached to a

financial instrument but is contractually transferable independently of that

instrument, or has a different counterparty, is not an embedded derivative, but a

separate financial instrument.

Hybrid contracts with financial asset hosts

4.3.2 If a hybrid contract contains a host that is an asset within the scope of this

Standard, an entity shall apply the requirements in paragraphs 4.1.1–4.1.5 to

the entire hybrid contract.

Other hybrid contracts

4.3.3 If a hybrid contract contains a host that is not an asset within the scope of this

Standard, an embedded derivative shall be separated from the host and

accounted for as a derivative under this Standard if, and only if:

(a) the economic characteristics and risks of the embedded derivative are

not closely related to the economic characteristics and risks of the host

(see paragraphs B4.3.5 and B4.3.8);

(b) a separate instrument with the same terms as the embedded derivative

would meet the definition of a derivative; and

(c) the hybrid contract is not measured at fair value with changes in fair

value recognised in profit or loss (ie a derivative that is embedded in a

financial liability at fair value through profit or loss is not separated).

4.3.4 If an embedded derivative is separated, the host contract shall be accounted for

in accordance with the appropriate Standards. This Standard does not address

whether an embedded derivative shall be presented separately in the statement

of financial position.

4.3.5 Despite paragraphs 4.3.3 and 4.3.4, if a contract contains one or more embedded

derivatives and the host is not an asset within the scope of this Standard, an

entity may designate the entire hybrid contract as at fair value through profit or

loss unless:

(a) the embedded derivative(s) do(es) not significantly modify the cash flows

that otherwise would be required by the contract; or

(b) it is clear with little or no analysis when a similar hybrid instrument is

first considered that separation of the embedded derivative(s) is

prohibited, such as a prepayment option embedded in a loan that

permits the holder to prepay the loan for approximately its amortised

cost.

4.3.6 If an entity is required by this Standard to separate an embedded derivative

from its host, but is unable to measure the embedded derivative separately

either at acquisition or at the end of a subsequent financial reporting period, it

shall designate the entire hybrid contract as at fair value through profit or loss.

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4.3.7 If an entity is unable to measure reliably the fair value of an embedded derivative on

the basis of its terms and conditions, the fair value of the embedded derivative is the

difference between the fair value of the hybrid contract and the fair value of the host.

If the entity is unable to measure the fair value of the embedded derivative using this

method, paragraph 4.3.6 applies and the hybrid contract is designated as at fair value

through profit or loss.

4.4 Reclassification

4.4.1 When, and only when, an entity changes its business model for managing

financial assets it shall reclassify all affected financial assets in accordance with

paragraphs 4.1.1–4.1.4. See paragraphs 5.6.1–5.6.7, B4.4.1–B4.4.3 and B5.6.1–

B5.6.2 for additional guidance on reclassifying financial assets.

4.4.2 An entity shall not reclassify any financial liability.

4.4.3 The following changes in circumstances are not reclassifications for the purposes of

paragraphs 4.4.1–4.4.2:

(a) an item that was previously a designated and effective hedging instrument in

a cash flow hedge or net investment hedge no longer qualifies as such;

(b) an item becomes a designated and effective hedging instrument in a cash

flow hedge or net investment hedge; and

(c) changes in measurement in accordance with Section 6.7.

Chapter 5 Measurement

5.1 Initial measurement

5.1.1 Except for trade receivables within the scope of paragraph 5.1.3, at initial

recognition, an entity shall measure a financial asset or financial liability at its

fair value plus or minus, in the case of a financial asset or financial liability not

at fair value through profit or loss, transaction costs that are directly

attributable to the acquisition or issue of the financial asset or financial liability.

5.1.1A However, if the fair value of the financial asset or financial liability at initial

recognition differs from the transaction price, an entity shall apply paragraph

B5.1.2A.

5.1.2 When an entity uses settlement date accounting for an asset that is subsequently

measured at amortised cost, the asset is recognised initially at its fair value on the

trade date (see paragraphs B3.1.3–B3.1.6).

5.1.3 Despite the requirement in paragraph 5.1.1, at initial recognition, an entity shall

measure trade receivables at their transaction price (as defined in NFRS 15) if the

trade receivables do not contain a significant financing component in accordance

with NFRS 15 (or when the entity applies the practical expedient in accordance with

paragraph 63 of NFRS 15).

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5.2 Subsequent measurement of financial assets

5.2.1 After initial recognition, an entity shall measure a financial asset in accordance

with paragraphs 4.1.1–4.1.5 at:

(a) amortised cost;

(b) fair value through other comprehensive income; or

(c) fair value through profit or loss.

5.2.2 An entity shall apply the impairment requirements in Section 5.5 to financial

assets that are measured at amortised cost in accordance with paragraph 4.1.2

and to financial assets that are measured at fair value through other

comprehensive income in accordance with paragraph 4.1.2A.

5.2.3 An entity shall apply the hedge accounting requirements in paragraphs 6.5.8–

6.5.14 (and, if applicable, paragraphs 89–94 of NAS 39 Financial Instruments:

Recognition and Measurement for the fair value hedge accounting for a portfolio

hedge of interest rate risk) to a financial asset that is designated as a hedged

item.1

5.3 Subsequent measurement of financial liabilities

5.3.1 After initial recognition, an entity shall measure a financial liability in

accordance with paragraphs 4.2.1–4.2.2.

5.3.2 An entity shall apply the hedge accounting requirements in paragraphs 6.5.8–

6.5.14 (and, if applicable, paragraphs 89–94 of NAS 39 for the fair value hedge

accounting for a portfolio hedge of interest rate risk) to a financial liability that

is designated as a hedged item.

5.4 Amortised cost measurement

Financial assets

Effective interest method

5.4.1 Interest revenue shall be calculated by using the effective interest method (see

Appendix A and paragraphs B5.4.1–B5.4.7). This shall be calculated by applying

the effective interest rate to the gross carrying amount of a financial asset except

for:

(a) purchased or originated credit-impaired financial assets. For those

financial assets, the entity shall apply the credit-adjusted effective interest

rate to the amortised cost of the financial asset from initial recognition.

(b) financial assets that are not purchased or originated credit-impaired

financial assets but subsequently have become credit-impaired financial

assets. For those financial assets, the entity shall apply the effective

interest rate to the amortised cost of the financial asset in subsequent

reporting periods.

1 �In accordance with paragraph 7.2.21, an entity may choose as its accounting policy to continue to apply the hedge accounting

requirements in NAS 39 instead of the requirements in Chapter 6 of this Standard. If an entity has made this election, the

references in this Standard to particular hedge accounting requirements in Chapter 6 are not relevant. Instead the entity applies

the relevant hedge accounting requirements in NAS 39.

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5.4.2 An entity that, in a reporting period, calculates interest revenue by applying the

effective interest method to the amortised cost of a financial asset in accordance with

paragraph 5.4.1(b), shall, in subsequent reporting periods, calculate the interest

revenue by applying the effective interest rate to the gross carrying amount if the

credit risk on the financial instrument improves so that the financial asset is no longer

credit-impaired and the improvement can be related objectively to an event occurring

after the requirements in paragraph 5.4.1(b) were applied (such as an improvement in

the borrower’s credit rating).

Modification of contractual cash flows

5.4.3 When the contractual cash flows of a financial asset are renegotiated or otherwise

modified and the renegotiation or modification does not result in the derecognition of

that financial asset in accordance with this Standard, an entity shall recalculate the

gross carrying amount of the financial asset and shall recognise a modification gain

or loss in profit or loss. The gross carrying amount of the financial asset shall be

recalculated as the present value of the renegotiated or modified contractual cash

flows that are discounted at the financial asset’s original effective interest rate (or

credit-adjusted effective interest rate for purchased or originated credit-impaired

financial assets) or, when applicable, the revised effective interest rate calculated in

accordance with paragraph 6.5.10. Any costs or fees incurred adjust the carrying

amount of the modified financial asset and are amortised over the remaining term of

the modified financial asset.

Write-off

5.4.4 An entity shall directly reduce the gross carrying amount of a financial asset

when the entity has no reasonable expectations of recovering a financial asset in

its entirety or a portion thereof. A write-off constitutes a derecognition event (see

paragraph B3.2.16(r)).

5.5 Impairment

Recognition of expected credit losses

General approach

5.5.1 An entity shall recognise a loss allowance for expected credit losses on a financial

asset that is measured in accordance with paragraphs 4.1.2 or 4.1.2A, a lease

receivable, a contract asset or a loan commitment and a financial guarantee

contract to which the impairment requirements apply in accordance with

paragraphs 2.1(g), 4.2.1(c) or 4.2.1(d).

5.5.2 An entity shall apply the impairment requirements for the recognition and

measurement of a loss allowance for financial assets that are measured at fair value

through other comprehensive income in accordance with paragraph 4.1.2A. However,

the loss allowance shall be recognised in other comprehensive income and shall not

reduce the carrying amount of the financial asset in the statement of financial

position.

5.5.3 Subject to paragraphs 5.5.13–5.5.16, at each reporting date, an entity shall

measure the loss allowance for a financial instrument at an amount equal to the

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lifetime expected credit losses if the credit risk on that financial instrument has

increased significantly since initial recognition.

5.5.4 The objective of the impairment requirements is to recognise lifetime expected credit

losses for all financial instruments for which there have been significant increases in

credit risk since initial recognition — whether assessed on an individual or collective

basis — considering all reasonable and supportable information, including that which

is forward-looking.

5.5.5 Subject to paragraphs 5.5.13–5.5.16, if, at the reporting date, the credit risk on a

financial instrument has not increased significantly since initial recognition, an

entity shall measure the loss allowance for that financial instrument at an

amount equal to 12-month expected credit losses.

5.5.6 For loan commitments and financial guarantee contracts, the date that the entity

becomes a party to the irrevocable commitment shall be considered to be the date of

initial recognition for the purposes of applying the impairment requirements.

5.5.7 If an entity has measured the loss allowance for a financial instrument at an amount

equal to lifetime expected credit losses in the previous reporting period, but

determines at the current reporting date that paragraph 5.5.3 is no longer met, the

entity shall measure the loss allowance at an amount equal to 12-month expected

credit losses at the current reporting date.

5.5.8 An entity shall recognise in profit or loss, as an impairment gain or loss, the amount

of expected credit losses (or reversal) that is required to adjust the loss allowance at

the reporting date to the amount that is required to be recognised in accordance with

this Standard.

Determining significant increases in credit risk

5.5.9 At each reporting date, an entity shall assess whether the credit risk on a financial

instrument has increased significantly since initial recognition. When making the

assessment, an entity shall use the change in the risk of a default occurring over the

expected life of the financial instrument instead of the change in the amount of

expected credit losses. To make that assessment, an entity shall compare the risk of a

default occurring on the financial instrument as at the reporting date with the risk of a

default occurring on the financial instrument as at the date of initial recognition and

consider reasonable and supportable information, that is available without undue cost

or effort, that is indicative of significant increases in credit risk since initial

recognition.

5.5.10 An entity may assume that the credit risk on a financial instrument has not increased

significantly since initial recognition if the financial instrument is determined to have

low credit risk at the reporting date (see paragraphs B5.5.22‒B5.5.24).

5.5.11 If reasonable and supportable forward-looking information is available without

undue cost or effort, an entity cannot rely solely on past due information when

determining whether credit risk has increased significantly since initial recognition.

However, when information that is more forward-looking than past due status (either

on an individual or a collective basis) is not available without undue cost or effort, an

entity may use past due information to determine whether there have been significant

increases in credit risk since initial recognition. Regardless of the way in which an

entity assesses significant increases in credit risk, there is a rebuttable presumption

that the credit risk on a financial asset has increased significantly since initial

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recognition when contractual payments are more than 30 days past due. An entity can

rebut this presumption if the entity has reasonable and supportable information that is

available without undue cost or effort, that demonstrates that the credit risk has not

increased significantly since initial recognition even though the contractual payments

are more than 30 days past due. When an entity determines that there have been

significant increases in credit risk before contractual payments are more than 30 days

past due, the rebuttable presumption does not apply.

Modified financial assets

5.5.12 If the contractual cash flows on a financial asset have been renegotiated or modified

and the financial asset was not derecognised, an entity shall assess whether there has

been a significant increase in the credit risk of the financial instrument in accordance

with paragraph 5.5.3 by comparing:

(a) the risk of a default occurring at the reporting date (based on the modified

contractual terms); and

(b) the risk of a default occurring at initial recognition (based on the original,

unmodified contractual terms).

Purchased or originated credit-impaired financial assets

5.5.13 Despite paragraphs 5.5.3 and 5.5.5, at the reporting date, an entity shall only

recognise the cumulative changes in lifetime expected credit losses since initial

recognition as a loss allowance for purchased or originated credit-impaired

financial assets.

5.5.14 At each reporting date, an entity shall recognise in profit or loss the amount of the

change in lifetime expected credit losses as an impairment gain or loss. An entity

shall recognise favourable changes in lifetime expected credit losses as an

impairment gain, even if the lifetime expected credit losses are less than the amount

of expected credit losses that were included in the estimated cash flows on initial

recognition.

Simplified approach for trade receivables, contract assets and lease receivables

5.5.15 Despite paragraphs 5.5.3 and 5.5.5, an entity shall always measure the loss

allowance at an amount equal to lifetime expected credit losses for:

(a) trade receivables or contract assets that result from transactions that are

within the scope of NFRS 15, and that:

(i) do not contain a significant financing component in accordance

with NFRS 15 (or when the entity applies the practical expedient

in accordance with paragraph 63 of NFRS 15); or

(ii) contain a significant financing component in accordance with

NFRS 15, if the entity chooses as its accounting policy to measure

the loss allowance at an amount equal to lifetime expected credit

losses. That accounting policy shall be applied to all such trade

receivables or contract assets but may be applied separately to

trade receivables and contract assets.

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(b) lease receivables that result from transactions that are within the scope

of NFRS 16, if the entity chooses as its accounting policy to measure the

loss allowance at an amount equal to lifetime expected credit losses. That

accounting policy shall be applied to all lease receivables but may be

applied separately to finance and operating lease receivables.

5.5.16 An entity may select its accounting policy for trade receivables, lease receivables and

contract assets independently of each other.

Measurement of expected credit losses

5.5.17 An entity shall measure expected credit losses of a financial instrument in a way

that reflects:

(a) an unbiased and probability-weighted amount that is determined by

evaluating a range of possible outcomes;

(b) the time value of money; and

(c) reasonable and supportable information that is available without undue

cost or effort at the reporting date about past events, current conditions

and forecasts of future economic conditions.

5.5.18 When measuring expected credit losses, an entity need not necessarily identify every

possible scenario. However, it shall consider the risk or probability that a credit loss

occurs by reflecting the possibility that a credit loss occurs and the possibility that no

credit loss occurs, even if the possibility of a credit loss occurring is very low.

5.5.19 The maximum period to consider when measuring expected credit losses is the

maximum contractual period (including extension options) over which the entity is

exposed to credit risk and not a longer period, even if that longer period is consistent

with business practice.

5.5.20 However, some financial instruments include both a loan and an undrawn

commitment component and the entity’s contractual ability to demand repayment and

cancel the undrawn commitment does not limit the entity’s exposure to credit losses

to the contractual notice period. For such financial instruments, and only those

financial instruments, the entity shall measure expected credit losses over the period

that the entity is exposed to credit risk and expected credit losses would not be

mitigated by credit risk management actions, even if that period extends beyond the

maximum contractual period.

5.6 Reclassification of financial assets

5.6.1 If an entity reclassifies financial assets in accordance with paragraph 4.4.1, it

shall apply the reclassification prospectively from the reclassification date. The

entity shall not restate any previously recognised gains, losses (including

impairment gains or losses) or interest. Paragraphs 5.6.2–5.6.7 set out the

requirements for reclassifications.

5.6.2 If an entity reclassifies a financial asset out of the amortised cost measurement

category and into the fair value through profit or loss measurement category, its

fair value is measured at the reclassification date. Any gain or loss arising from a

difference between the previous amortised cost of the financial asset and fair

value is recognised in profit or loss.

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5.6.3 If an entity reclassifies a financial asset out of the fair value through profit or

loss measurement category and into the amortised cost measurement category,

its fair value at the reclassification date becomes its new gross carrying amount.

(See paragraph B5.6.2 for guidance on determining an effective interest rate and

a loss allowance at the reclassification date.)

5.6.4 If an entity reclassifies a financial asset out of the amortised cost measurement

category and into the fair value through other comprehensive income

measurement category, its fair value is measured at the reclassification date. Any

gain or loss arising from a difference between the previous amortised cost of the

financial asset and fair value is recognised in other comprehensive income. The

effective interest rate and the measurement of expected credit losses are not

adjusted as a result of the reclassification. (See paragraph B5.6.1.)

5.6.5 If an entity reclassifies a financial asset out of the fair value through other

comprehensive income measurement category and into the amortised cost

measurement category, the financial asset is reclassified at its fair value at the

reclassification date. However, the cumulative gain or loss previously recognised

in other comprehensive income is removed from equity and adjusted against the

fair value of the financial asset at the reclassification date. As a result, the

financial asset is measured at the reclassification date as if it had always been

measured at amortised cost. This adjustment affects other comprehensive

income but does not affect profit or loss and therefore is not a reclassification

adjustment (see NAS 1 Presentation of Financial Statements). The effective

interest rate and the measurement of expected credit losses are not adjusted as a

result of the reclassification. (See paragraph B5.6.1.)

5.6.6 If an entity reclassifies a financial asset out of the fair value through profit or

loss measurement category and into the fair value through other comprehensive

income measurement category, the financial asset continues to be measured at

fair value. (See paragraph B5.6.2 for guidance on determining an effective

interest rate and a loss allowance at the reclassification date.)

5.6.7 If an entity reclassifies a financial asset out of the fair value through other

comprehensive income measurement category and into the fair value through

profit or loss measurement category, the financial asset continues to be

measured at fair value. The cumulative gain or loss previously recognised in

other comprehensive income is reclassified from equity to profit or loss as a

reclassification adjustment (see NAS 1) at the reclassification date.

5.7 Gains and losses

5.7.1 A gain or loss on a financial asset or financial liability that is measured at fair

value shall be recognised in profit or loss unless:

(a) it is part of a hedging relationship (see paragraphs 6.5.8–6.5.14 and, if

applicable, paragraphs 89–94 of NAS 39 for the fair value hedge

accounting for a portfolio hedge of interest rate risk);

(b) it is an investment in an equity instrument and the entity has elected to

present gains and losses on that investment in other comprehensive

income in accordance with paragraph 5.7.5;

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(c) it is a financial liability designated as at fair value through profit or loss

and the entity is required to present the effects of changes in the

liability’s credit risk in other comprehensive income in accordance with

paragraph 5.7.7; or

(d) it is a financial asset measured at fair value through other

comprehensive income in accordance with paragraph 4.1.2A and the

entity is required to recognise some changes in fair value in other

comprehensive income in accordance with paragraph 5.7.10.

5.7.1A Dividends are recognised in profit or loss only when:

(a) the entity’s right to receive payment of the dividend is established;

(b) it is probable that the economic benefits associated with the dividend will

flow to the entity; and

(c) the amount of the dividend can be measured reliably.

5.7.2 A gain or loss on a financial asset that is measured at amortised cost and is not

part of a hedging relationship (see paragraphs 6.5.8–6.5.14 and, if applicable,

paragraphs 89–94 of NAS 39 for the fair value hedge accounting for a portfolio

hedge of interest rate risk) shall be recognised in profit or loss when the

financial asset is derecognised, reclassified in accordance with paragraph 5.6.2,

through the amortisation process or in order to recognise impairment gains or

losses. An entity shall apply paragraphs 5.6.2 and 5.6.4 if it reclassifies financial

assets out of the amortised cost measurement category. A gain or loss on a

financial liability that is measured at amortised cost and is not part of a hedging

relationship (see paragraphs 6.5.8–6.5.14 and, if applicable, paragraphs 89–94 of

NAS 39 for the fair value hedge accounting for a portfolio hedge of interest rate

risk) shall be recognised in profit or loss when the financial liability is

derecognised and through the amortisation process. (See paragraph B5.7.2 for

guidance on foreign exchange gains or losses.)

5.7.3 A gain or loss on financial assets or financial liabilities that are hedged items in a

hedging relationship shall be recognised in accordance with paragraphs 6.5.8–

6.5.14 and, if applicable, paragraphs 89–94 of NAS 39 for the fair value hedge

accounting for a portfolio hedge of interest rate risk.

5.7.4 If an entity recognises financial assets using settlement date accounting (see

paragraphs 3.1.2, B3.1.3 and B3.1.6), any change in the fair value of the asset to

be received during the period between the trade date and the settlement date is

not recognised for assets measured at amortised cost. For assets measured at fair

value, however, the change in fair value shall be recognised in profit or loss or in

other comprehensive income, as appropriate in accordance with paragraph

5.7.1. The trade date shall be considered the date of initial recognition for the

purposes of applying the impairment requirements.

Investments in equity instruments

5.7.5 At initial recognition, an entity may make an irrevocable election to present in

other comprehensive income subsequent changes in the fair value of an

investment in an equity instrument within the scope of this Standard that is

neither held for trading nor contingent consideration recognised by an acquirer

in a business combination to which NFRS 3 applies. (See paragraph B5.7.3 for

guidance on foreign exchange gains or losses.)

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5.7.6 If an entity makes the election in paragraph 5.7.5, it shall recognise in profit or loss

dividends from that investment in accordance with paragraph 5.7.1A.

Liabilities designated as at fair value through profit or loss

5.7.7 An entity shall present a gain or loss on a financial liability that is designated as

at fair value through profit or loss in accordance with paragraph 4.2.2 or

paragraph 4.3.5 as follows:

(a) The amount of change in the fair value of the financial liability that is

attributable to changes in the credit risk of that liability shall be

presented in other comprehensive income (see paragraphs B5.7.13–

B5.7.20), and

(b) the remaining amount of change in the fair value of the liability shall be

presented in profit or loss

unless the treatment of the effects of changes in the liability’s credit risk

described in (a) would create or enlarge an accounting mismatch in profit or loss

(in which case paragraph 5.7.8 applies). Paragraphs B5.7.5–B5.7.7 and B5.7.10–

B5.7.12 provide guidance on determining whether an accounting mismatch

would be created or enlarged.

5.7.8 If the requirements in paragraph 5.7.7 would create or enlarge an accounting

mismatch in profit or loss, an entity shall present all gains or losses on that

liability (including the effects of changes in the credit risk of that liability) in

profit or loss.

5.7.9 Despite the requirements in paragraphs 5.7.7 and 5.7.8, an entity shall present in

profit or loss all gains and losses on loan commitments and financial guarantee

contracts that are designated as at fair value through profit or loss.

Assets measured at fair value through other comprehensive income

5.7.10 A gain or loss on a financial asset measured at fair value through other

comprehensive income in accordance with paragraph 4.1.2A shall be recognised

in other comprehensive income, except for impairment gains or losses (see

Section 5.5) and foreign exchange gains and losses (see paragraphs B5.7.2–

B5.7.2A), until the financial asset is derecognised or reclassified. When the

financial asset is derecognised the cumulative gain or loss previously recognised

in other comprehensive income is reclassified from equity to profit or loss as a

reclassification adjustment (see NAS 1). If the financial asset is reclassified out

of the fair value through other comprehensive income measurement category,

the entity shall account for the cumulative gain or loss that was previously

recognised in other comprehensive income in accordance with paragraphs 5.6.5

and 5.6.7. Interest calculated using the effective interest method is recognised in

profit or loss.

5.7.11 As described in paragraph 5.7.10, if a financial asset is measured at fair value

through other comprehensive income in accordance with paragraph 4.1.2A, the

amounts that are recognised in profit or loss are the same as the amounts that

would have been recognised in profit or loss if the financial asset had been

measured at amortised cost.

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Chapter 6 Hedge accounting

6.1 Objective and scope of hedge accounting

6.1.1 The objective of hedge accounting is to represent, in the financial statements, the

effect of an entity’s risk management activities that use financial instruments to

manage exposures arising from particular risks that could affect profit or loss (or

other comprehensive income, in the case of investments in equity instruments for

which an entity has elected to present changes in fair value in other comprehensive

income in accordance with paragraph 5.7.5). This approach aims to convey the

context of hedging instruments for which hedge accounting is applied in order to

allow insight into their purpose and effect.

6.1.2 An entity may choose to designate a hedging relationship between a hedging

instrument and a hedged item in accordance with paragraphs 6.2.1–6.3.7 and B6.2.1–

B6.3.25. For hedging relationships that meet the qualifying criteria, an entity shall

account for the gain or loss on the hedging instrument and the hedged item in

accordance with paragraphs 6.5.1–6.5.14 and B6.5.1–B6.5.28. When the hedged item

is a group of items, an entity shall comply with the additional requirements in

paragraphs 6.6.1–6.6.6 and B6.6.1–B6.6.16.

6.1.3 For a fair value hedge of the interest rate exposure of a portfolio of financial assets or

financial liabilities (and only for such a hedge), an entity may apply the hedge

accounting requirements in NAS 39 instead of those in this Standard. In that case, the

entity must also apply the specific requirements for the fair value hedge accounting

for a portfolio hedge of interest rate risk and designate as the hedged item a portion

that is a currency amount (see paragraphs 81A, 89A and AG114–AG132 of NAS 39).

6.2 Hedging instruments

Qualifying instruments

6.2.1 A derivative measured at fair value through profit or loss may be designated as

a hedging instrument, except for some written options (see paragraph B6.2.4).

6.2.2 A non-derivative financial asset or a non-derivative financial liability measured

at fair value through profit or loss may be designated as a hedging instrument

unless it is a financial liability designated as at fair value through profit or loss

for which the amount of its change in fair value that is attributable to changes in

the credit risk of that liability is presented in other comprehensive income in

accordance with paragraph 5.7.7. For a hedge of foreign currency risk, the

foreign currency risk component of a non-derivative financial asset or a non-

derivative financial liability may be designated as a hedging instrument

provided that it is not an investment in an equity instrument for which an entity

has elected to present changes in fair value in other comprehensive income in


6.2.3 For hedge accounting purposes, only contracts with a party external to the

reporting entity (ie external to the group or individual entity that is being

reported on) can be designated as hedging instruments.

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Designation of hedging instruments

6.2.4 A qualifying instrument must be designated in its entirety as a hedging instrument.

The only exceptions permitted are:

(a) separating the intrinsic value and time value of an option contract and

designating as the hedging instrument only the change in intrinsic value of an

option and not the change in its time value (see paragraphs 6.5.15 and

B6.5.29–B6.5.33);

(b) separating the forward element and the spot element of a forward contract

and designating as the hedging instrument only the change in the value of the

spot element of a forward contract and not the forward element; similarly, the

foreign currency basis spread may be separated and excluded from the

designation of a financial instrument as the hedging instrument (see

paragraphs 6.5.16 and B6.5.34–B6.5.39); and

(c) a proportion of the entire hedging instrument, such as 50 per cent of the

nominal amount, may be designated as the hedging instrument in a hedging

relationship. However, a hedging instrument may not be designated for a part

of its change in fair value that results from only a portion of the time period

during which the hedging instrument remains outstanding.

6.2.5 An entity may view in combination, and jointly designate as the hedging instrument,

any combination of the following (including those circumstances in which the risk or

risks arising from some hedging instruments offset those arising from others):

(a) derivatives or a proportion of them; and

(b) non-derivatives or a proportion of them.

6.2.6 However, a derivative instrument that combines a written option and a purchased

option (for example, an interest rate collar) does not qualify as a hedging instrument

if it is, in effect, a net written option at the date of designation (unless it qualifies in

accordance with paragraph B6.2.4). Similarly, two or more instruments (or

proportions of them) may be jointly designated as the hedging instrument only if, in

combination, they are not, in effect, a net written option at the date of designation

(unless it qualifies in accordance with paragraph B6.2.4).

6.3 Hedged items

Qualifying items

6.3.1 A hedged item can be a recognised asset or liability, an unrecognised firm

commitment, a forecast transaction or a net investment in a foreign operation.

The hedged item can be:

(a) a single item; or

(b) a group of items (subject to paragraphs 6.6.1–6.6.6 and B6.6.1–B6.6.16).

A hedged item can also be a component of such an item or group of items (see

paragraphs 6.3.7 and B6.3.7–B6.3.25).

6.3.2 The hedged item must be reliably measurable.

6.3.3 If a hedged item is a forecast transaction (or a component thereof), that

transaction must be highly probable.

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6.3.4 An aggregated exposure that is a combination of an exposure that could qualify

as a hedged item in accordance with paragraph 6.3.1 and a derivative may be

designated as a hedged item (see paragraphs B6.3.3–B6.3.4). This includes a

forecast transaction of an aggregated exposure (ie uncommitted but anticipated

future transactions that would give rise to an exposure and a derivative) if that

aggregated exposure is highly probable and, once it has occurred and is

therefore no longer forecast, is eligible as a hedged item.

6.3.5 For hedge accounting purposes, only assets, liabilities, firm commitments or

highly probable forecast transactions with a party external to the reporting

entity can be designated as hedged items. Hedge accounting can be applied to

transactions between entities in the same group only in the individual or

separate financial statements of those entities and not in the consolidated

financial statements of the group, except for the consolidated financial

statements of an investment entity, as defined in NFRS 10, where transactions

between an investment entity and its subsidiaries measured at fair value through

profit or loss will not be eliminated in the consolidated financial statements.

6.3.6 However, as an exception to paragraph 6.3.5, the foreign currency risk of an

intragroup monetary item (for example, a payable/receivable between two

subsidiaries) may qualify as a hedged item in the consolidated financial statements if

it results in an exposure to foreign exchange rate gains or losses that are not fully

eliminated on consolidation in accordance with NAS 21 The Effects of Changes in

Foreign Exchange Rates. In accordance with NAS 21, foreign exchange rate gains

and losses on intragroup monetary items are not fully eliminated on consolidation

when the intragroup monetary item is transacted between two group entities that have

different functional currencies. In addition, the foreign currency risk of a highly

probable forecast intragroup transaction may qualify as a hedged item in consolidated

financial statements provided that the transaction is denominated in a currency other

than the functional currency of the entity entering into that transaction and the foreign

currency risk will affect consolidated profit or loss.

Designation of hedged items

6.3.7 An entity may designate an item in its entirety or a component of an item as the

hedged item in a hedging relationship. An entire item comprises all changes in the

cash flows or fair value of an item. A component comprises less than the entire fair

value change or cash flow variability of an item. In that case, an entity may designate

only the following types of components (including combinations) as hedged items:

(a) only changes in the cash flows or fair value of an item attributable to a

specific risk or risks (risk component), provided that, based on an assessment

within the context of the particular market structure, the risk component is

separately identifiable and reliably measurable (see paragraphs B6.3.8–

B6.3.15). Risk components include a designation of only changes in the cash

flows or the fair value of a hedged item above or below a specified price or

other variable (a one-sided risk).

(b) one or more selected contractual cash flows.

(c) components of a nominal amount, ie a specified part of the amount of an item

(see paragraphs B6.3.16–B6.3.20).

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6.4 Qualifying criteria for hedge accounting

6.4.1 A hedging relationship qualifies for hedge accounting only if all of the following

criteria are met:

(a) the hedging relationship consists only of eligible hedging instruments

and eligible hedged items.

(b) at the inception of the hedging relationship there is formal designation

and documentation of the hedging relationship and the entity’s risk

management objective and strategy for undertaking the hedge. That

documentation shall include identification of the hedging instrument, the

hedged item, the nature of the risk being hedged and how the entity will

assess whether the hedging relationship meets the hedge effectiveness

requirements (including its analysis of the sources of hedge

ineffectiveness and how it determines the hedge ratio).

(c) the hedging relationship meets all of the following hedge effectiveness

requirements:

(i) there is an economic relationship between the hedged item and

the hedging instrument (see paragraphs B6.4.4–B6.4.6);

(ii) the effect of credit risk does not dominate the value changes that

result from that economic relationship (see paragraphs B6.4.7–

B6.4.8); and

(iii) the hedge ratio of the hedging relationship is the same as that

resulting from the quantity of the hedged item that the entity

actually hedges and the quantity of the hedging instrument that

the entity actually uses to hedge that quantity of hedged item.

However, that designation shall not reflect an imbalance between

the weightings of the hedged item and the hedging instrument

that would create hedge ineffectiveness (irrespective of whether

recognised or not) that could result in an accounting outcome

that would be inconsistent with the purpose of hedge accounting

(see paragraphs B6.4.9–B6.4.11).

6.5 Accounting for qualifying hedging relationships

6.5.1 An entity applies hedge accounting to hedging relationships that meet the

qualifying criteria in paragraph 6.4.1 (which include the entity’s decision to

designate the hedging relationship).

6.5.2 There are three types of hedging relationships:

(a) fair value hedge: a hedge of the exposure to changes in fair value of a

recognised asset or liability or an unrecognised firm commitment, or a

component of any such item, that is attributable to a particular risk and

could affect profit or loss.

(b) cash flow hedge: a hedge of the exposure to variability in cash flows that

is attributable to a particular risk associated with all, or a component of,

a recognised asset or liability (such as all or some future interest

payments on variable-rate debt) or a highly probable forecast

transaction, and could affect profit or loss.

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(c) hedge of a net investment in a foreign operation as defined in NAS 21.

6.5.3 If the hedged item is an equity instrument for which an entity has elected to present

changes in fair value in other comprehensive income in accordance with paragraph

5.7.5, the hedged exposure referred to in paragraph 6.5.2(a) must be one that could

affect other comprehensive income. In that case, and only in that case, the recognised

hedge ineffectiveness is presented in other comprehensive income.

6.5.4 A hedge of the foreign currency risk of a firm commitment may be accounted for as a

fair value hedge or a cash flow hedge.

6.5.5 If a hedging relationship ceases to meet the hedge effectiveness requirement

relating to the hedge ratio (see paragraph 6.4.1(c)(iii)) but the risk management

objective for that designated hedging relationship remains the same, an entity

shall adjust the hedge ratio of the hedging relationship so that it meets the

qualifying criteria again (this is referred to in this Standard as ‘rebalancing’—

see paragraphs B6.5.7–B6.5.21).

6.5.6 An entity shall discontinue hedge accounting prospectively only when the

hedging relationship (or a part of a hedging relationship) ceases to meet the

qualifying criteria (after taking into account any rebalancing of the hedging

relationship, if applicable). This includes instances when the hedging instrument

expires or is sold, terminated or exercised. For this purpose, the replacement or

rollover of a hedging instrument into another hedging instrument is not an

expiration or termination if such a replacement or rollover is part of, and

consistent with, the entity’s documented risk management objective.

Additionally, for this purpose there is not an expiration or termination of the

hedging instrument if:

(a) as a consequence of laws or regulations or the introduction of laws or

regulations, the parties to the hedging instrument agree that one or more

clearing counterparties replace their original counterparty to become

the new counterparty to each of the parties. For this purpose, a clearing

counterparty is a central counterparty (sometimes called a ‘clearing

organisation’ or ‘clearing agency’) or an entity or entities, for example, a

clearing member of a clearing organisation or a client of a clearing

member of a clearing organisation, that are acting as a counterparty in

order to effect clearing by a central counterparty. However, when the

parties to the hedging instrument replace their original counterparties

with different counterparties the requirement in this subparagraph is

met only if each of those parties effects clearing with the same central

counterparty.

(b) other changes, if any, to the hedging instrument are limited to those that

are necessary to effect such a replacement of the counterparty. Such

changes are limited to those that are consistent with the terms that

would be expected if the hedging instrument were originally cleared with

the clearing counterparty. These changes include changes in the

collateral requirements, rights to offset receivables and payables

balances, and charges levied.

Discontinuing hedge accounting can either affect a hedging relationship in its

entirety or only a part of it (in which case hedge accounting continues for the

remainder of the hedging relationship).

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6.5.7 An entity shall apply:

(a) paragraph 6.5.10 when it discontinues hedge accounting for a fair value

hedge for which the hedged item is (or is a component of) a financial

instrument measured at amortised cost; and

(b) paragraph 6.5.12 when it discontinues hedge accounting for cash flow

hedges.

Fair value hedges

6.5.8 As long as a fair value hedge meets the qualifying criteria in paragraph 6.4.1,

the hedging relationship shall be accounted for as follows:

(a) the gain or loss on the hedging instrument shall be recognised in profit

or loss (or other comprehensive income, if the hedging instrument

hedges an equity instrument for which an entity has elected to present

changes in fair value in other comprehensive income in accordance with

paragraph 5.7.5).

(b) the hedging gain or loss on the hedged item shall adjust the carrying

amount of the hedged item (if applicable) and be recognised in profit or

loss. If the hedged item is a financial asset (or a component thereof) that

is measured at fair value through other comprehensive income in

accordance with paragraph 4.1.2A, the hedging gain or loss on the

hedged item shall be recognised in profit or loss. However, if the hedged

item is an equity instrument for which an entity has elected to present

changes in fair value in other comprehensive income in accordance with

paragraph 5.7.5, those amounts shall remain in other comprehensive

income. When a hedged item is an unrecognised firm commitment (or a

component thereof), the cumulative change in the fair value of the

hedged item subsequent to its designation is recognised as an asset or a

liability with a corresponding gain or loss recognised in profit or loss.

6.5.9 When a hedged item in a fair value hedge is a firm commitment (or a component

thereof) to acquire an asset or assume a liability, the initial carrying amount of the

asset or the liability that results from the entity meeting the firm commitment is

adjusted to include the cumulative change in the fair value of the hedged item that

was recognised in the statement of financial position.

6.5.10 Any adjustment arising from paragraph 6.5.8(b) shall be amortised to profit or loss if

the hedged item is a financial instrument (or a component thereof) measured at

amortised cost. Amortisation may begin as soon as an adjustment exists and shall

begin no later than when the hedged item ceases to be adjusted for hedging gains and

losses. The amortisation is based on a recalculated effective interest rate at the date

that amortisation begins. In the case of a financial asset (or a component thereof) that

is a hedged item and that is measured at fair value through other comprehensive

income in accordance with paragraph 4.1.2A, amortisation applies in the same

manner but to the amount that represents the cumulative gain or loss previously

recognised in accordance with paragraph 6.5.8(b) instead of by adjusting the carrying

amount.

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Cash flow hedges

6.5.11 As long as a cash flow hedge meets the qualifying criteria in paragraph 6.4.1, the

hedging relationship shall be accounted for as follows:

(a) the separate component of equity associated with the hedged item (cash

flow hedge reserve) is adjusted to the lower of the following (in absolute

amounts):

(i) the cumulative gain or loss on the hedging instrument from

inception of the hedge; and

(ii) the cumulative change in fair value (present value) of the hedged

item (ie the present value of the cumulative change in the hedged

expected future cash flows) from inception of the hedge.

(b) the portion of the gain or loss on the hedging instrument that is

determined to be an effective hedge (ie the portion that is offset by the

change in the cash flow hedge reserve calculated in accordance with (a))

shall be recognised in other comprehensive income.

(c) any remaining gain or loss on the hedging instrument (or any gain or

loss required to balance the change in the cash flow hedge reserve

calculated in accordance with (a)) is hedge ineffectiveness that shall be

recognised in profit or loss.

(d) the amount that has been accumulated in the cash flow hedge reserve in

accordance with (a) shall be accounted for as follows:

(i) if a hedged forecast transaction subsequently results in the

recognition of a non-financial asset or non-financial liability, or a

hedged forecast transaction for a non-financial asset or a non-

financial liability becomes a firm commitment for which fair

value hedge accounting is applied, the entity shall remove that

amount from the cash flow hedge reserve and include it directly

in the initial cost or other carrying amount of the asset or the

liability. This is not a reclassification adjustment (see NAS 1) and

hence it does not affect other comprehensive income.

(ii) for cash flow hedges other than those covered by (i), that amount

shall be reclassified from the cash flow hedge reserve to profit or

loss as a reclassification adjustment (see NAS 1) in the same

period or periods during which the hedged expected future cash

flows affect profit or loss (for example, in the periods that

interest income or interest expense is recognised or when a

forecast sale occurs).

(iii) however, if that amount is a loss and an entity expects that all or

a portion of that loss will not be recovered in one or more future

periods, it shall immediately reclassify the amount that is not

expected to be recovered into profit or loss as a reclassification

adjustment (see NAS 1).

6.5.12 When an entity discontinues hedge accounting for a cash flow hedge (see paragraphs

6.5.6 and 6.5.7(b)) it shall account for the amount that has been accumulated in the

cash flow hedge reserve in accordance with paragraph 6.5.11(a) as follows:

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(a) if the hedged future cash flows are still expected to occur, that amount shall

remain in the cash flow hedge reserve until the future cash flows occur or

until paragraph 6.5.11(d)(iii) applies. When the future cash flows occur,

paragraph 6.5.11(d) applies.

(b) if the hedged future cash flows are no longer expected to occur, that amount

shall be immediately reclassified from the cash flow hedge reserve to profit

or loss as a reclassification adjustment (see NAS 1). A hedged future cash

flow that is no longer highly probable to occur may still be expected to occur.

Hedges of a net investment in a foreign operation

6.5.13 Hedges of a net investment in a foreign operation, including a hedge of a

monetary item that is accounted for as part of the net investment (see NAS 21),

shall be accounted for similarly to cash flow hedges:

(a) the portion of the gain or loss on the hedging instrument that is

determined to be an effective hedge shall be recognised in other

comprehensive income (see paragraph 6.5.11); and

(b) the ineffective portion shall be recognised in profit or loss.

6.5.14 The cumulative gain or loss on the hedging instrument relating to the effective

portion of the hedge that has been accumulated in the foreign currency

translation reserve shall be reclassified from equity to profit or loss as a

reclassification adjustment (see NAS 1) in accordance with paragraphs 48–49 of

NAS 21 on the disposal or partial disposal of the foreign operation.

Accounting for the time value of options

6.5.15 When an entity separates the intrinsic value and time value of an option contract and

designates as the hedging instrument only the change in intrinsic value of the option

(see paragraph 6.2.4(a)), it shall account for the time value of the option as follows

(see paragraphs B6.5.29–B6.5.33):

(a) an entity shall distinguish the time value of options by the type of hedged

item that the option hedges (see paragraph B6.5.29):

(i) a transaction related hedged item; or

(ii) a time-period related hedged item.

(b) the change in fair value of the time value of an option that hedges a

transaction related hedged item shall be recognised in other comprehensive

income to the extent that it relates to the hedged item and shall be

accumulated in a separate component of equity. The cumulative change in

fair value arising from the time value of the option that has been accumulated

in a separate component of equity (the ‘amount’) shall be accounted for as

follows:

(i) if the hedged item subsequently results in the recognition of a non-

financial asset or a non-financial liability, or a firm commitment for a

non-financial asset or a non-financial liability for which fair value

hedge accounting is applied, the entity shall remove the amount from

the separate component of equity and include it directly in the initial

cost or other carrying amount of the asset or the liability. This is not a

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reclassification adjustment (see NAS 1) and hence does not affect

other comprehensive income.

(ii) for hedging relationships other than those covered by (i), the amount

shall be reclassified from the separate component of equity to profit

or loss as a reclassification adjustment (see NAS 1) in the same

period or periods during which the hedged expected future cash

flows affect profit or loss (for example, when a forecast sale occurs).

(iii) however, if all or a portion of that amount is not expected to be

recovered in one or more future periods, the amount that is not

expected to be recovered shall be immediately reclassified into profit

or loss as a reclassification adjustment (see NAS 1).

(c) the change in fair value of the time value of an option that hedges a time-

period related hedged item shall be recognised in other comprehensive

income to the extent that it relates to the hedged item and shall be

accumulated in a separate component of equity. The time value at the date of

designation of the option as a hedging instrument, to the extent that it relates

to the hedged item, shall be amortised on a systematic and rational basis over

the period during which the hedge adjustment for the option’s intrinsic value

could affect profit or loss (or other comprehensive income, if the hedged item

is an equity instrument for which an entity has elected to present changes in

fair value in other comprehensive income in accordance with paragraph

5.7.5). Hence, in each reporting period, the amortisation amount shall be

reclassified from the separate component of equity to profit or loss as a

reclassification adjustment (see NAS 1). However, if hedge accounting is

discontinued for the hedging relationship that includes the change in intrinsic

value of the option as the hedging instrument, the net amount (ie including

cumulative amortisation) that has been accumulated in the separate

component of equity shall be immediately reclassified into profit or loss as a

reclassification adjustment (see NAS 1).

Accounting for the forward element of forward contracts and foreign currency basis spreads of financial instruments

6.5.16 When an entity separates the forward element and the spot element of a forward

contract and designates as the hedging instrument only the change in the value of the

spot element of the forward contract, or when an entity separates the foreign currency

basis spread from a financial instrument and excludes it from the designation of that

financial instrument as the hedging instrument (see paragraph 6.2.4(b)), the entity

may apply paragraph 6.5.15 to the forward element of the forward contract or to the

foreign currency basis spread in the same manner as it is applied to the time value of

an option. In that case, the entity shall apply the application guidance in paragraphs

B6.5.34–B6.5.39.

6.6 Hedges of a group of items

Eligibility of a group of items as the hedged item

6.6.1 A group of items (including a group of items that constitute a net position; see

paragraphs B6.6.1–B6.6.8) is an eligible hedged item only if:

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(a) it consists of items (including components of items) that are, individually,

eligible hedged items;

(b) the items in the group are managed together on a group basis for risk

management purposes; and

(c) in the case of a cash flow hedge of a group of items whose variabilities in

cash flows are not expected to be approximately proportional to the

overall variability in cash flows of the group so that offsetting risk

positions arise:

(i) it is a hedge of foreign currency risk; and

(ii) the designation of that net position specifies the reporting period

in which the forecast transactions are expected to affect profit or

loss, as well as their nature and volume (see paragraphs B6.6.7–

B6.6.8).

Designation of a component of a nominal amount

6.6.2 A component that is a proportion of an eligible group of items is an eligible hedged

item provided that designation is consistent with the entity’s risk management

objective.

6.6.3 A layer component of an overall group of items (for example, a bottom layer) is

eligible for hedge accounting only if:

(a) it is separately identifiable and reliably measurable;

(b) the risk management objective is to hedge a layer component;

(c) the items in the overall group from which the layer is identified are exposed

to the same hedged risk (so that the measurement of the hedged layer is not

significantly affected by which particular items from the overall group form

part of the hedged layer);

(d) for a hedge of existing items (for example, an unrecognised firm

commitment or a recognised asset) an entity can identify and track the

overall group of items from which the hedged layer is defined (so that the

entity is able to comply with the requirements for the accounting for

qualifying hedging relationships); and

(e) any items in the group that contain prepayment options meet the

requirements for components of a nominal amount (see paragraph B6.3.20).

Presentation

6.6.4 For a hedge of a group of items with offsetting risk positions (ie in a hedge of a net

position) whose hedged risk affects different line items in the statement of profit or

loss and other comprehensive income, any hedging gains or losses in that statement

shall be presented in a separate line from those affected by the hedged items. Hence,

in that statement the amount in the line item that relates to the hedged item itself (for

example, revenue or cost of sales) remains unaffected.

6.6.5 For assets and liabilities that are hedged together as a group in a fair value hedge, the

gain or loss in the statement of financial position on the individual assets and

liabilities shall be recognised as an adjustment of the carrying amount of the

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respective individual items comprising the group in accordance with paragraph

6.5.8(b).

Nil net positions

6.6.6 When the hedged item is a group that is a nil net position (ie the hedged items among

themselves fully offset the risk that is managed on a group basis), an entity is

permitted to designate it in a hedging relationship that does not include a hedging

instrument, provided that:

(a) the hedge is part of a rolling net risk hedging strategy, whereby the entity

routinely hedges new positions of the same type as time moves on (for

example, when transactions move into the time horizon for which the entity

hedges);

(b) the hedged net position changes in size over the life of the rolling net risk

hedging strategy and the entity uses eligible hedging instruments to hedge the

net risk (ie when the net position is not nil);

(c) hedge accounting is normally applied to such net positions when the net

position is not nil and it is hedged with eligible hedging instruments; and

(d) not applying hedge accounting to the nil net position would give rise to

inconsistent accounting outcomes, because the accounting would not

recognise the offsetting risk positions that would otherwise be recognised in

a hedge of a net position.

6.7 Option to designate a credit exposure as measured at fair value through profit or loss

Eligibility of credit exposures for designation at fair value through profitor loss

6.7.1 If an entity uses a credit derivative that is measured at fair value through profit

or loss to manage the credit risk of all, or a part of, a financial instrument

(credit exposure) it may designate that financial instrument to the extent that it

is so managed (ie all or a proportion of it) as measured at fair value through

profit or loss if:

(a) the name of the credit exposure (for example, the borrower, or the holder

of a loan commitment) matches the reference entity of the credit

derivative (‘name matching’); and

(b) the seniority of the financial instrument matches that of the instruments

that can be delivered in accordance with the credit derivative.

An entity may make this designation irrespective of whether the financial

instrument that is managed for credit risk is within the scope of this Standard

(for example, an entity may designate loan commitments that are outside the

scope of this Standard). The entity may designate that financial instrument at,

or subsequent to, initial recognition, or while it is unrecognised. The entity shall

document the designation concurrently.

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Accounting for credit exposures designated at fair value through profit or loss

6.7.2 If a financial instrument is designated in accordance with paragraph 6.7.1 as

measured at fair value through profit or loss after its initial recognition, or was

previously not recognised, the difference at the time of designation between the

carrying amount, if any, and the fair value shall immediately be recognised in profit

or loss. For financial assets measured at fair value through other comprehensive

income in accordance with paragraph 4.1.2A, the cumulative gain or loss previously

recognised in other comprehensive income shall immediately be reclassified from

equity to profit or loss as a reclassification adjustment (see NAS 1).

6.7.3 An entity shall discontinue measuring the financial instrument that gave rise to the

credit risk, or a proportion of that financial instrument, at fair value through profit or

loss if:

(a) the qualifying criteria in paragraph 6.7.1 are no longer met, for example:

(i) the credit derivative or the related financial instrument that gives rise

to the credit risk expires or is sold, terminated or settled; or

(ii) the credit risk of the financial instrument is no longer managed using

credit derivatives. For example, this could occur because of

improvements in the credit quality of the borrower or the loan

commitment holder or changes to capital requirements imposed on

an entity; and

(b) the financial instrument that gives rise to the credit risk is not otherwise

required to be measured at fair value through profit or loss (ie the entity’s

business model has not changed in the meantime so that a reclassification in

accordance with paragraph 4.4.1 was required).

6.7.4 When an entity discontinues measuring the financial instrument that gives rise to the

credit risk, or a proportion of that financial instrument, at fair value through profit or

loss, that financial instrument’s fair value at the date of discontinuation becomes its

new carrying amount. Subsequently, the same measurement that was used before

designating the financial instrument at fair value through profit or loss shall be

applied (including amortisation that results from the new carrying amount). For

example, a financial asset that had originally been classified as measured at amortised

cost would revert to that measurement and its effective interest rate would be

recalculated based on its new gross carrying amount on the date of discontinuing

measurement at fair value through profit or loss.

Chapter 7 Effective date and transition

7.1 Effective date

7.1.1 An entity shall apply this Standard for annual periods beginning on or after July 16,

2020. Earlier application is permitted. If an entity elects to apply this Standard early,

it must disclose that fact and apply all of the requirements in this Standard at the

same time (but see also paragraphs 7.1.2, 7.2.21 and 7.3.2). It shall also, at the same

time, apply the amendments in Appendix C.

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Any consequential effect arising from the application of other related Standards

becoming effective on the later date, shall be applied only when those Standards

come into effect.

7.1.2 [Deleted]

7.1.3 [Deleted]

7.1.4 [Deleted]

7.1.5 [Deleted]

7.1.6 [Deleted]

7.1.7 [Deleted]

7.2 Transition

7.2.1 An entity shall apply this Standard retrospectively, in accordance with NAS 8

Accounting Policies, Changes in Accounting Estimates and Errors , except as

specified in paragraphs 7.2.4–7.2.26 and 7.2.28. This Standard shall not be applied to

items that have already been derecognised at the date of initial application.

7.2.2 For the purposes of the transition provisions in paragraphs 7.2.1, 7.2.3–7.2.28 and

7.3.2, the date of initial application is the date when an entity first applies those

requirements of this Standard and must be the beginning of a reporting period after

the issue of this Standard. Depending on the entity’s chosen approach to applying

NFRS 9, the transition can involve one or more than one date of initial application for

different requirements.

Transition for classification and measurement (Chapters 4 and 5)

7.2.3 At the date of initial application, an entity shall assess whether a financial asset meets

the condition in paragraphs 4.1.2(a) or 4.1.2A(a) on the basis of the facts and

circumstances that exist at that date. The resulting classification shall be applied

retrospectively irrespective of the entity’s business model in prior reporting periods.

7.2.4 If, at the date of initial application, it is impracticable (as defined in NAS 8) for an

entity to assess a modified time value of money element in accordance with

paragraphs B4.1.9B–B4.1.9D on the basis of the facts and circumstances that existed

at the initial recognition of the financial asset, an entity shall assess the contractual

cash flow characteristics of that financial asset on the basis of the facts and

circumstances that existed at the initial recognition of the financial asset without

taking into account the requirements related to the modification of the time value of

money element in paragraphs B4.1.9B–B4.1.9D. (See also paragraph 42R of NFRS

7.)

7.2.5 If, at the date of initial application, it is impracticable (as defined in NAS 8) for an

entity to assess whether the fair value of a prepayment feature was insignificant in

accordance with paragraph B4.1.12(c) on the basis of the facts and circumstances that

existed at the initial recognition of the financial asset, an entity shall assess the

contractual cash flow characteristics of that financial asset on the basis of the facts

and circumstances that existed at the initial recognition of the financial asset without

taking into account the exception for prepayment features in paragraph B4.1.12. (See

also paragraph 42S of NFRS 7.)

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7.2.6 If an entity measures a hybrid contract at fair value in accordance with paragraphs

4.1.2A, 4.1.4 or 4.1.5 but the fair value of the hybrid contract had not been measured

in comparative reporting periods, the fair value of the hybrid contract in the

comparative reporting periods shall be the sum of the fair values of the components

(ie the non-derivative host and the embedded derivative) at the end of each

comparative reporting period if the entity restates prior periods (see paragraph

7.2.15).

7.2.7 If an entity has applied paragraph 7.2.6 then at the date of initial application the entity

shall recognise any difference between the fair value of the entire hybrid contract at

the date of initial application and the sum of the fair values of the components of the

hybrid contract at the date of initial application in the opening retained earnings (or

other component of equity, as appropriate) of the reporting period that includes the

date of initial application.

7.2.8 At the date of initial application an entity may designate:

(a) a financial asset as measured at fair value through profit or loss in accordance

with paragraph 4.1.5; or

(b) an investment in an equity instrument as at fair value through other

comprehensive income in accordance with paragraph 5.7.5.

Such a designation shall be made on the basis of the facts and circumstances that

exist at the date of initial application. That classification shall be applied

retrospectively.

7.2.9 At the date of initial application an entity:

(a) shall revoke its previous designation of a financial asset as measured at fair

value through profit or loss if that financial asset does not meet the condition

in paragraph 4.1.5.

(b) may revoke its previous designation of a financial asset as measured at fair

value through profit or loss if that financial asset meets the condition in

paragraph 4.1.5.

Such a revocation shall be made on the basis of the facts and circumstances that exist

at the date of initial application. That classification shall be applied retrospectively.

7.2.10 At the date of initial application, an entity:

(a) may designate a financial liability as measured at fair value through profit or

loss in accordance with paragraph 4.2.2(a).

(b) shall revoke its previous designation of a financial liability as measured at

fair value through profit or loss if such designation was made at initial

recognition in accordance with the condition now in paragraph 4.2.2(a) and

such designation does not satisfy that condition at the date of initial

application.

(c) may revoke its previous designation of a financial liability as measured at

fair value through profit or loss if such designation was made at initial

recognition in accordance with the condition now in paragraph 4.2.2(a) and

such designation satisfies that condition at the date of initial application.

Such a designation and revocation shall be made on the basis of the facts and

circumstances that exist at the date of initial application. That classification shall be

applied retrospectively.

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7.2.11 If it is impracticable (as defined in NAS 8) for an entity to apply retrospectively the

effective interest method, the entity shall treat:

(a) the fair value of the financial asset or the financial liability at the end of each

comparative period presented as the gross carrying amount of that financial

asset or the amortised cost of that financial liability if the entity restates prior

periods; and

(b) the fair value of the financial asset or the financial liability at the date of

initial application as the new gross carrying amount of that financial asset or

the new amortised cost of that financial liability at the date of initial

application of this Standard.

7.2.12 If an entity previously accounted at cost (in accordance with NAS 39), for an

investment in an equity instrument that does not have a quoted price in an active

market for an identical instrument (ie a Level 1 input) (or for a derivative asset that is

linked to and must be settled by delivery of such an equity instrument) it shall

measure that instrument at fair value at the date of initial application. Any difference

between the previous carrying amount and the fair value shall be recognised in the

opening retained earnings (or other component of equity, as appropriate) of the

reporting period that includes the date of initial application.

7.2.13 If an entity previously accounted for a derivative liability that is linked to, and must

be settled by, delivery of an equity instrument that does not have a quoted price in an

active market for an identical instrument (ie a Level 1 input) at cost in accordance

with NAS 39, it shall measure that derivative liability at fair value at the date of

initial application. Any difference between the previous carrying amount and the fair

value shall be recognised in the opening retained earnings of the reporting period that

includes the date of initial application.

7.2.14 At the date of initial application, an entity shall determine whether the treatment in

paragraph 5.7.7 would create or enlarge an accounting mismatch in profit or loss on

the basis of the facts and circumstances that exist at the date of initial application.

This Standard shall be applied retrospectively on the basis of that determination.

7.2.14AAt the date of initial application, an entity is permitted to make the designation in

paragraph 2.5 for contracts that already exist on the date but only if it designates all

similar contracts. The change in the net assets resulting from such designations shall

be recognised in retained earnings at the date of initial application.

7.2.15 Despite the requirement in paragraph 7.2.1, an entity that adopts the classification

and measurement requirements of this Standard (which include the requirements

related to amortised cost measurement for financial assets and impairment in

Sections 5.4 and 5.5) shall provide the disclosures set out in paragraphs 42L–42O of

NFRS 7 but need not restate prior periods. The entity may restate prior periods if, and

only if, it is possible without the use of hindsight. If an entity does not restate prior

periods, the entity shall recognise any difference between the previous carrying

amount and the carrying amount at the beginning of the annual reporting period that

includes the date of initial application in the opening retained earnings (or other

component of equity, as appropriate) of the annual reporting period that includes the

date of initial application. However, if an entity restates prior periods, the restated

financial statements must reflect all of the requirements in this Standard. If an entity’s

chosen approach to applying NFRS 9 results in more than one date of initial

application for different requirements, this paragraph applies at each date of initial

application (see paragraph 7.2.2). This would be the case, for example, if an entity

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elects to early apply only the requirements for the presentation of gains and losses on

financial liabilities designated as at fair value through profit or loss in accordance

with paragraph 7.1.2 before applying the other requirements in this Standard.

7.2.16 If an entity prepares interim financial reports in accordance with NAS 34 Interim

Financial Reporting the entity need not apply the requirements in this Standard to

interim periods prior to the date of initial application if it is impracticable (as defined

in NAS 8).

Impairment (Section 5.5)

7.2.17 An entity shall apply the impairment requirements in Section 5.5 retrospectively in

accordance with NAS 8 subject to paragraphs 7.2.15 and 7.2.18–7.2.20.

7.2.18 At the date of initial application, an entity shall use reasonable and supportable

information that is available without undue cost or effort to determine the credit risk

at the date that a financial instrument was initially recognised (or for loan

commitments and financial guarantee contracts at the date that the entity became a

party to the irrevocable commitment in accordance with paragraph 5.5.6) and

compare that to the credit risk at the date of initial application of this Standard.

7.2.19 When determining whether there has been a significant increase in credit risk since

initial recognition, an entity may apply:

(a) the requirements in paragraphs 5.5.10 and B5.5.22–B5.5.24; and

(b) the rebuttable presumption in paragraph 5.5.11 for contractual payments that

are more than 30 days past due if an entity will apply the impairment

requirements by identifying significant increases in credit risk since initial

recognition for those financial instruments on the basis of past due

information.

7.2.20 If, at the date of initial application, determining whether there has been a significant

increase in credit risk since initial recognition would require undue cost or effort, an

entity shall recognise a loss allowance at an amount equal to lifetime expected credit

losses at each reporting date until that financial instrument is derecognised (unless

that financial instrument is low credit risk at a reporting date, in which case

paragraph 7.2.19(a) applies).

Transition for hedge accounting (Chapter 6)

7.2.21 When an entity first applies this Standard, it may choose as its accounting policy to

continue to apply the hedge accounting requirements of NAS 39 instead of the

requirements in Chapter 6 of this Standard. An entity shall apply that policy to all of

its hedging relationships. An entity that chooses that policy shall also apply IFRIC 16

Hedges of a Net Investment in a Foreign Operation without the amendments that

conform that Interpretation to the requirements in Chapter 6 of this Standard.

7.2.22 Except as provided in paragraph 7.2.26, an entity shall apply the hedge accounting

requirements of this Standard prospectively.

7.2.23 To apply hedge accounting from the date of initial application of the hedge

accounting requirements of this Standard, all qualifying criteria must be met as at that

date.

7.2.24 Hedging relationships that qualified for hedge accounting in accordance with NAS

39 that also qualify for hedge accounting in accordance with the criteria of this

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Standard (see paragraph 6.4.1), after taking into account any rebalancing of the

hedging relationship on transition (see paragraph 7.2.25(b)), shall be regarded as

continuing hedging relationships.

7.2.25 On initial application of the hedge accounting requirements of this Standard, an

entity:

(a) may start to apply those requirements from the same point in time as it ceases

to apply the hedge accounting requirements of NAS 39; and

(b) shall consider the hedge ratio in accordance with NAS 39 as the starting

point for rebalancing the hedge ratio of a continuing hedging relationship, if

applicable. Any gain or loss from such a rebalancing shall be recognised in

profit or loss.

7.2.26 As an exception to prospective application of the hedge accounting requirements of

this Standard, an entity:

(a) shall apply the accounting for the time value of options in accordance with

paragraph 6.5.15 retrospectively if, in accordance with NAS 39, only the

change in an option’s intrinsic value was designated as a hedging instrument

in a hedging relationship. This retrospective application applies only to those

hedging relationships that existed at the beginning of the earliest comparative

period or were designated thereafter.

(b) may apply the accounting for the forward element of forward contracts in

accordance with paragraph 6.5.16 retrospectively if, in accordance with NAS

39, only the change in the spot element of a forward contract was designated

as a hedging instrument in a hedging relationship. This retrospective

application applies only to those hedging relationships that existed at the

beginning of the earliest comparative period or were designated thereafter. In

addition, if an entity elects retrospective application of this accounting, it

shall be applied to all hedging relationships that qualify for this election (ie

on transition this election is not available on a hedging-relationship-by-

hedging-relationship basis). The accounting for foreign currency basis

spreads (see paragraph 6.5.16) may be applied retrospectively for those

hedging relationships that existed at the beginning of the earliest comparative

period or were designated thereafter.

(c) shall apply retrospectively the requirement of paragraph 6.5.6 that there is

not an expiration or termination of the hedging instrument if:

(i) as a consequence of laws or regulations, or the introduction of laws

or regulations, the parties to the hedging instrument agree that one or

more clearing counterparties replace their original counterparty to

become the new counterparty to each of the parties; and

(ii) other changes, if any, to the hedging instrument are limited to those

that are necessary to effect such a replacement of the counterparty.

Entities that have applied NFRS 9 (2013) early

7.2.27 An entity shall apply the transition requirements in paragraphs 7.2.1–7.2.26 at the

relevant date of initial application. An entity shall apply each of the transition

provisions in paragraphs 7.2.3–7.2.14A and 7.2.17–7.2.26 only once (ie if an entity

chooses an approach of applying NFRS 9 that involves more than one date of initial

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application, it cannot apply any of those provisions again if they were already applied

at an earlier date). (See paragraphs 7.2.2 and 7.3.2.)

7.2.28 An entity that applied NFRS 9 (2013) and subsequently applies this Standard:


value through profit or loss if that designation was previously made in

accordance with the condition in paragraph 4.1.5 but that condition is no

longer satisfied as a result of the application of this Standard;

(b) may designate a financial asset as measured at fair value through profit or

loss if that designation would not have previously satisfied the condition in

paragraph 4.1.5 but that condition is now satisfied as a result of the

application of this Standard;

(c) shall revoke its previous designation of a financial liability as measured at

fair value through profit or loss if that designation was previously made in

accordance with the condition in paragraph 4.2.2(a) but that condition is no

longer satisfied as a result of the application of this Standard; and

(d) may designate a financial liability as measured at fair value through profit or


paragraph 4.2.2(a) but that condition is now satisfied as a result of the

application of this Standard.


circumstances that exist at the date of initial application of this Standard. That

classification shall be applied retrospectively.

Transition for Prepayment Features with Negative Compensation

7.2.29 An entity shall apply Prepayment Features with Negative Compensation

(Amendments to NFRS 9) retrospectively in accordance with NAS 8, except as

specified in paragraphs 7.2.30–7.2.34.

7.2.30 An entity that first applies these amendments at the same time it first applies this

Standard shall apply paragraphs 7.2.1–7.2.28 instead of paragraphs 7.2.31–7.2.34.

7.2.31 An entity that first applies these amendments after it first applies this Standard shall

apply paragraphs 7.2.32–7.2.34. The entity shall also apply the other transition

requirements in this Standard necessary for applying these amendments. For that

purpose, references to the date of initial application shall be read as referring to the

beginning of the reporting period in which an entity first applies these amendments

(date of initial application of these amendments).

7.2.32 With regard to designating a financial asset or financial liability as measured at fair

value through profit or loss, an entity:


value through profit or loss if that designation was previously made in

accordance with the condition in paragraph 4.1.5 but that condition is no

longer satisfied as a result of the application of these amendments;

(b) may designate a financial asset as measured at fair value through profit or


paragraph 4.1.5 but that condition is now satisfied as a result of the

application of these amendments;

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(c) shall revoke its previous designation of a financial liability as measured at

fair value through profit or loss if that designation was previously made in

accordance with the condition in paragraph 4.2.2(a) but that condition is no

longer satisfied as a result of the application of these amendments; and

(d) may designate a financial liability as measured at fair value through profit or


paragraph 4.2.2(a) but that condition is now satisfied as a result of the

application of these amendments.


circumstances that exist at the date of initial application of these amendments. That

classification shall be applied retrospectively.

7.2.33 An entity is not required to restate prior periods to reflect the application of these

amendments. The entity may restate prior periods if, and only if, it is possible without

the use of hindsight and the restated financial statements reflect all the requirements

in this Standard. If an entity does not restate prior periods, the entity shall recognise

any difference between the previous carrying amount and the carrying amount at the

beginning of the annual reporting period that includes the date of initial application

of these amendments in the opening retained earnings (or other component of equity,

as appropriate) of the annual reporting period that includes the date of initial

application of these amendments.

7.2.34 In the reporting period that includes the date of initial application of these

amendments, the entity shall disclose the following information as at that date of

initial application for each class of financial assets and financial liabilities that were

affected by these amendments:

(a) the previous measurement category and carrying amount determined

immediately before applying these amendments;

(b) the new measurement category and carrying amount determined after

applying these amendments;

(c) the carrying amount of any financial assets and financial liabilities in the

statement of financial position that were previously designated as measured

at fair value through profit or loss but are no longer so designated; and

(d) the reasons for any designation or de-designation of financial assets or

financial liabilities as measured at fair value through profit or loss.

7.3 Withdrawal of NFRS 9 (2013)

7.3.1 [Deleted]

7.3.2 This Standard supersedes NFRS 9 (2013). However, for annual periods beginning

before 16 July 2020, an entity may elect to apply the earlier version of NFRS 9

instead of applying this Standard.

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Appendix A Defined terms

This appendix is an integral part of the Standard.

12-month expected

credit losses

The portion of lifetime expected credit losses that represent the

expected credit losses that result from default events on a financial

instrument that are possible within the 12 months after the reporting

date.

amortised cost of a

financial asset or

financial liability

The amount at which the financial asset or financial liability is

measured at initial recognition minus the principal repayments, plus

or minus the cumulative amortisation using the effective interest

method of any difference between that initial amount and the

maturity amount and, for financial assets, adjusted for any loss

allowance.

contract assets Those rights that NFRS 15 Revenue from Contracts with Customers

specifies are accounted for in accordance with this Standard for the

purposes of recognising and measuring impairment gains or losses.

credit-impaired

financial asset

A financial asset is credit-impaired when one or more events that

have a detrimental impact on the estimated future cash flows of that

financial asset have occurred. Evidence that a financial asset is

credit-impaired include observable data about the following events:

(a) significant financial difficulty of the issuer or the borrower;

(b) a breach of contract, such as a default or past due event;

(c) the lender(s) of the borrower, for economic or contractual

reasons relating to the borrower’s financial difficulty,

having granted to the borrower a concession(s) that the

lender(s) would not otherwise consider;

(d) it is becoming probable that the borrower will enter

bankruptcy or other financial reorganisation;

(e) the disappearance of an active market for that financial asset

because of financial difficulties; or

(f) the purchase or origination of a financial asset at a deep

discount that reflects the incurred credit losses.

It may not be possible to identify a single discrete event—instead,

the combined effect of several events may have caused financial

assets to become credit-impaired.

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credit loss The difference between all contractual cash flows that are due to an

entity in accordance with the contract and all the cash flows that the

entity expects to receive (ie all cash shortfalls), discounted at the

original effective interest rate (or credit-adjusted effective

interest rate for purchased or originated credit-impaired

financial assets). An entity shall estimate cash flows by considering

all contractual terms of the financial instrument (for example,

prepayment, extension, call and similar options) through the

expected life of that financial instrument. The cash flows that are

considered shall include cash flows from the sale of collateral held

or other credit enhancements that are integral to the contractual

terms. There is a presumption that the expected life of a financial

instrument can be estimated reliably. However, in those rare cases

when it is not possible to reliably estimate the expected life of a

financial instrument, the entity shall use the remaining contractual

term of the financial instrument.

credit-adjusted

effective interest rate

The rate that exactly discounts the estimated future cash payments

or receipts through the expected life of the financial asset to the

amortised cost of a financial asset that is a purchased or

originated credit-impaired financial asset. When calculating the

credit-adjusted effective interest rate, an entity shall estimate the

expected cash flows by considering all contractual terms of the

financial asset (for example, prepayment, extension, call and similar

options) and expected credit losses. The calculation includes all

fees and points paid or received between parties to the contract that

are an integral part of the effective interest rate (see paragraphs

B5.4.1‒B5.4.3), transaction costs, and all other premiums or

discounts. There is a presumption that the cash flows and the

expected life of a group of similar financial instruments can be

estimated reliably. However, in those rare cases when it is not

possible to reliably estimate the cash flows or the remaining life of a

financial instrument (or group of financial instruments), the entity

shall use the contractual cash flows over the full contractual term of

the financial instrument (or group of financial instruments).

derecognition The removal of a previously recognised financial asset or financial

liability from an entity’s statement of financial position.

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derivative A financial instrument or other contract within the scope of this

Standard with all three of the following characteristics.

(a) its value changes in response to the change in a specified

interest rate, financial instrument price, commodity price,

foreign exchange rate, index of prices or rates, credit rating

or credit index, or other variable, provided in the case of a

non-financial variable that the variable is not specific to a

party to the contract (sometimes called the ‘underlying’).

(b) it requires no initial net investment or an initial net

investment that is smaller than would be required for other

types of contracts that would be expected to have a similar

response to changes in market factors.

(c) it is settled at a future date.

dividends Distributions of profits to holders of equity instruments in

proportion to their holdings of a particular class of capital.

effective interest

method

The method that is used in the calculation of the amortised cost of a

financial asset or a financial liability and in the allocation and

recognition of the interest revenue or interest expense in profit or

loss over the relevant period.

effective interest rate The rate that exactly discounts estimated future cash payments or

receipts through the expected life of the financial asset or financial

liability to the gross carrying amount of a financial asset or to the

amortised cost of a financial liability. When calculating the

effective interest rate, an entity shall estimate the expected cash

flows by considering all the contractual terms of the financial

instrument (for example, prepayment, extension, call and similar

options) but shall not consider the expected credit losses. The

calculation includes all fees and points paid or received between

parties to the contract that are an integral part of the effective

interest rate (see paragraphs B5.4.1–B5.4.3), transaction costs, and

all other premiums or discounts. There is a presumption that the

cash flows and the expected life of a group of similar financial

instruments can be estimated reliably. However, in those rare cases

when it is not possible to reliably estimate the cash flows or the

expected life of a financial instrument (or group of financial

instruments), the entity shall use the contractual cash flows over the

full contractual term of the financial instrument (or group of

financial instruments).

expected credit

losses

The weighted average of credit losses with the respective risks of a

default occurring as the weights.

financial guarantee

contract

A contract that requires the issuer to make specified payments to

reimburse the holder for a loss it incurs because a specified debtor

fails to make payment when due in accordance with the original or

modified terms of a debt instrument.

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financial liability at

fair value through

profit or loss

A financial liability that meets one of the following conditions:

(a) it meets the definition of held for trading.

(b) upon initial recognition it is designated by the entity as at

fair value through profit or loss in accordance with

paragraph 4.2.2 or 4.3.5.

(c) it is designated either upon initial recognition or

subsequently as at fair value through profit or loss in


firm commitment A binding agreement for the exchange of a specified quantity of

resources at a specified price on a specified future date or dates.

forecast transaction An uncommitted but anticipated future transaction.

gross carrying

amount of a

financial asset

The amortised cost of a financial asset, before adjusting for any

loss allowance.

hedge ratio The relationship between the quantity of the hedging instrument and

the quantity of the hedged item in terms of their relative weighting.

held for trading A financial asset or financial liability that:

(a) is acquired or incurred principally for the purpose of selling

or repurchasing it in the near term;

(b) on initial recognition is part of a portfolio of identified

financial instruments that are managed together and for

which there is evidence of a recent actual pattern of short-

term profit-taking; or

(c) is a derivative (except for a derivative that is a financial

guarantee contract or a designated and effective hedging

instrument).

impairment gain or

loss

Gains or losses that are recognised in profit or loss in accordance

with paragraph 5.5.8 and that arise from applying the impairment

requirements in Section 5.5.

lifetime expected

credit losses

The expected credit losses that result from all possible default

events over the expected life of a financial instrument.

loss allowance The allowance for expected credit losses on financial assets

measured in accordance with paragraph 4.1.2, lease receivables and

contract assets, the accumulated impairment amount for financial

assets measured in accordance with paragraph 4.1.2A and the

provision for expected credit losses on loan commitments and

financial guarantee contracts.

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modification gain or

loss

The amount arising from adjusting the gross carrying amount of a

financial asset to reflect the renegotiated or modified contractual

cash flows. The entity recalculates the gross carrying amount of a

financial asset as the present value of the estimated future cash

payments or receipts through the expected life of the renegotiated or

modified financial asset that are discounted at the financial asset’s

original effective interest rate (or the original credit-adjusted

effective interest rate for purchased or originated credit-

impaired financial assets) or, when applicable, the revised

effective interest rate calculated in accordance with paragraph

6.5.10. When estimating the expected cash flows of a financial asset,

an entity shall consider all contractual terms of the financial asset

(for example, prepayment, call and similar options) but shall not

consider the expected credit losses, unless the financial asset is a

purchased or originated credit-impaired financial asset, in which

case an entity shall also consider the initial expected credit losses

that were considered when calculating the original credit-adjusted

effective interest rate.

past due A financial asset is past due when a counterparty has failed to make

a payment when that payment was contractually due.

purchased or

originated credit-

impaired financial

asset

Purchased or originated financial asset(s) that are credit-impaired

on initial recognition.

reclassification date The first day of the first reporting period following the change in

business model that results in an entity reclassifying financial assets.

regular way

purchase or sale

A purchase or sale of a financial asset under a contract whose terms

require delivery of the asset within the time frame established

generally by regulation or convention in the marketplace concerned.

transaction costs Incremental costs that are directly attributable to the acquisition,

issue or disposal of a financial asset or financial liability (see

paragraph B5.4.8). An incremental cost is one that would not have

been incurred if the entity had not acquired, issued or disposed of

the financial instrument.

The following terms are defined in paragraph 11 of NAS 32, Appendix A of NFRS 7,

Appendix A of NFRS 13 or Appendix A of NFRS 15 and are used in this Standard with the

meanings specified in NAS 32, NFRS 7, NFRS 13 or NFRS 15:

(a) credit risk;2

(b) equity instrument;

(c) fair value;

(d) financial asset;

(e) financial instrument;

2 �This term (as defined in NFRS 7) is used in the requirements for presenting the effects of changes in credit risk on liabilities

designated as at fair value through profit or loss (see paragraph 5.7.7).

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(f) financial liability;

(g) transaction price.

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Appendix B Application guidance

This appendix is an integral part of the Standard.

Scope (Chapter 2)

B2.1 Some contracts require a payment based on climatic, geological or other physical

variables. (Those based on climatic variables are sometimes referred to as ‘weather

derivatives’.) If those contracts are not within the scope of NFRS 17 Insurance

Contracts, they are within the scope of this Standard.

B2.2 This Standard does not change the requirements relating to employee benefit plans

that comply with NAS 26 Accounting and Reporting by Retirement Benefit Plans and

royalty agreements based on the volume of sales or service revenues that are

accounted for under NFRS 15 Revenue from Contracts with Customers.

B2.3 Sometimes, an entity makes what it views as a ‘strategic investment’ in equity

instruments issued by another entity, with the intention of establishing or maintaining

a long-term operating relationship with the entity in which the investment is made.

The investor or joint venturer entity uses NAS 28 Investments in Associates and Joint

Ventures to determine whether the equity method of accounting shall be applied to

such an investment.

B2.4 This Standard applies to the financial assets and financial liabilities of insurers, other

than rights and obligations that paragraph 2.1(e) excludes because they arise under

contracts within the scope of NFRS 17.

B2.5 Financial guarantee contracts may have various legal forms, such as a guarantee,

some types of letter of credit, a credit default contract or an insurance contract. Their

accounting treatment does not depend on their legal form. The following are

examples of the appropriate treatment (see paragraph 2.1(e)):

(a) Although a financial guarantee contract meets the definition of an insurance

contract in NFRS 17 (see paragraph 7(e) of NFRS 17) if the risk transferred

is significant, the issuer applies this Standard. Nevertheless, if the issuer has

previously asserted explicitly that it regards such contracts as insurance

contracts and has used accounting that is applicable to insurance contracts,

the issuer may elect to apply either this Standard or NFRS 17 to such

financial guarantee contracts. If this Standard applies, paragraph 5.1.1

requires the issuer to recognise a financial guarantee contract initially at fair

value. If the financial guarantee contract was issued to an unrelated party in a

stand-alone arm’s length transaction, its fair value at inception is likely to

equal the premium received, unless there is evidence to the contrary.

Subsequently, unless the financial guarantee contract was designated at

inception as at fair value through profit or loss or unless paragraphs 3.2.15–

3.2.23 and B3.2.12–B3.2.17 apply (when a transfer of a financial asset does

not qualify for derecognition or the continuing involvement approach

applies), the issuer measures it at the higher of:

(i) the amount determined in accordance with Section 5.5; and

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(ii) the amount initially recognised less, when appropriate, the

cumulative amount of income recognised in accordance with the

principles of NFRS 15 (see paragraph 4.2.1(c)).

(b) Some credit-related guarantees do not, as a precondition for payment, require

that the holder is exposed to, and has incurred a loss on, the failure of the

debtor to make payments on the guaranteed asset when due. An example of

such a guarantee is one that requires payments in response to changes in a

specified credit rating or credit index. Such guarantees are not financial

guarantee contracts as defined in this Standard, and are not insurance

contracts as defined in NFRS 17. Such guarantees are derivatives and the

issuer applies this Standard to them.

(c) If a financial guarantee contract was issued in connection with the sale of

goods, the issuer applies NFRS 15 in determining when it recognises the

revenue from the guarantee and from the sale of goods.

B2.6 Assertions that an issuer regards contracts as insurance contracts are typically found

throughout the issuer’s communications with customers and regulators, contracts,

business documentation and financial statements. Furthermore, insurance contracts

are often subject to accounting requirements that are distinct from the requirements

for other types of transaction, such as contracts issued by banks or commercial

companies. In such cases, an issuer’s financial statements typically include a

statement that the issuer has used those accounting requirements.

Recognition and derecognition (Chapter 3)

Initial recognition (Section 3.1)

B3.1.1 As a consequence of the principle in paragraph 3.1.1, an entity recognises all of its

contractual rights and obligations under derivatives in its statement of financial

position as assets and liabilities, respectively, except for derivatives that prevent a

transfer of financial assets from being accounted for as a sale (see paragraph

B3.2.14). If a transfer of a financial asset does not qualify for derecognition, the

transferee does not recognise the transferred asset as its asset (see paragraph

B3.2.15).

B3.1.2 The following are examples of applying the principle in paragraph 3.1.1:

(a) Unconditional receivables and payables are recognised as assets or liabilities

when the entity becomes a party to the contract and, as a consequence, has a

legal right to receive or a legal obligation to pay cash.

(b) Assets to be acquired and liabilities to be incurred as a result of a firm

commitment to purchase or sell goods or services are generally not

recognised until at least one of the parties has performed under the

agreement. For example, an entity that receives a firm order does not

generally recognise an asset (and the entity that places the order does not

recognise a liability) at the time of the commitment but, instead, delays

recognition until the ordered goods or services have been shipped, delivered

or rendered. If a firm commitment to buy or sell non-financial items is within

the scope of this Standard in accordance with paragraphs 2.4–2.7, its net fair

value is recognised as an asset or a liability on the commitment date (see

paragraph B4.1.30(c)). In addition, if a previously unrecognised firm

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commitment is designated as a hedged item in a fair value hedge, any change

in the net fair value attributable to the hedged risk is recognised as an asset or

a liability after the inception of the hedge (see paragraphs 6.5.8(b) and 6.5.9).

(c) A forward contract that is within the scope of this Standard (see paragraph

2.1) is recognised as an asset or a liability on the commitment date, instead of

on the date on which settlement takes place. When an entity becomes a party

to a forward contract, the fair values of the right and obligation are often

equal, so that the net fair value of the forward is zero. If the net fair value of

the right and obligation is not zero, the contract is recognised as an asset or

liability.

(d) Option contracts that are within the scope of this Standard (see paragraph

2.1) are recognised as assets or liabilities when the holder or writer becomes

a party to the contract.

(e) Planned future transactions, no matter how likely, are not assets and

liabilities because the entity has not become a party to a contract.

Regular way purchase or sale of financial assets

B3.1.3 A regular way purchase or sale of financial assets is recognised using either trade

date accounting or settlement date accounting as described in paragraphs B3.1.5 and

B3.1.6. An entity shall apply the same method consistently for all purchases and sales

of financial assets that are classified in the same way in accordance with this

Standard. For this purpose assets that are mandatorily measured at fair value through

profit or loss form a separate classification from assets designated as measured at fair

value through profit or loss. In addition, investments in equity instruments accounted

for using the option provided in paragraph 5.7.5 form a separate classification.

B3.1.4 A contract that requires or permits net settlement of the change in the value of the

contract is not a regular way contract. Instead, such a contract is accounted for as a

derivative in the period between the trade date and the settlement date.

B3.1.5 The trade date is the date that an entity commits itself to purchase or sell an asset.

Trade date accounting refers to (a) the recognition of an asset to be received and the

liability to pay for it on the trade date, and (b) derecognition of an asset that is sold,

recognition of any gain or loss on disposal and the recognition of a receivable from

the buyer for payment on the trade date. Generally, interest does not start to accrue on

the asset and corresponding liability until the settlement date when title passes.

B3.1.6 The settlement date is the date that an asset is delivered to or by an entity. Settlement

date accounting refers to (a) the recognition of an asset on the day it is received by

the entity, and (b) the derecognition of an asset and recognition of any gain or loss on

disposal on the day that it is delivered by the entity. When settlement date accounting

is applied an entity accounts for any change in the fair value of the asset to be

received during the period between the trade date and the settlement date in the same

way as it accounts for the acquired asset. In other words, the change in value is not

recognised for assets measured at amortised cost; it is recognised in profit or loss for

assets classified as financial assets measured at fair value through profit or loss; and

it is recognised in other comprehensive income for financial assets measured at fair

value through other comprehensive income in accordance with paragraph 4.1.2A and

for investments in equity instruments accounted for in accordance with paragraph

5.7.5.

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Derecognition of financial assets (Section 3.2)

B3.2.1 The following flow chart illustrates the evaluation of whether and to what extent a

financial asset is derecognised.

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Has the entity retainedcontrol of the asset?[Paragraph 3.2.6(c)]

Yes

No

Consolidate all subsidiaries [Paragraph 3.2.1]

Determine whether the derecognition principles below areapplied to a part or all of an asset (or group of similar assets)

[Paragraph 3.2.2]

Has the entity retainedsubstantially all risks andrewards?[Paragraph 3.2.6(b)]

Has the entity transferredsubstantially all risksand rewards?[Paragraph 3.2.6(a)]

Continue to recognise the asset to the extent of the entity’scontinuing involvement

No

No

Yes

Derecognise the asset

Continue to recognise the asset

Derecognise the asset

Continue to recognise the asset

Yes

Yes

Yes

Derecognise the assetNo

No

Have the rights to the cash flowsfrom the asset expired?

[Paragraph 3.2.3(a)]

Has the entity assumed an obligation to paythe cash flows from the asset that meets

the conditions in paragraph 3.2.5?[Paragraph 3.2.4(b)]

No

Has the entity transferred its rights toreceive the cash flows from the asset?

[Paragraph 3.2.4(a)]

Yes

Arrangements under which an entity retains the contractual rights to receive the cash flows of a financial asset, but assumes a contractual obligation to pay the cash flows to one or more recipients (paragraph 3.2.4(b))

B3.2.2 The situation described in paragraph 3.2.4(b) (when an entity retains the contractual

rights to receive the cash flows of the financial asset, but assumes a contractual

obligation to pay the cash flows to one or more recipients) occurs, for example, if the

entity is a trust, and issues to investors beneficial interests in the underlying financial

assets that it owns and provides servicing of those financial assets. In that case, the

financial assets qualify for derecognition if the conditions in paragraphs 3.2.5 and

3.2.6 are met.

B3.2.3 In applying paragraph 3.2.5, the entity could be, for example, the originator of the

financial asset, or it could be a group that includes a subsidiary that has acquired the

financial asset and passes on cash flows to unrelated third party investors.

Evaluation of the transfer of risks and rewards of ownership (paragraph 3.2.6)

B3.2.4 Examples of when an entity has transferred substantially all the risks and rewards of

ownership are:

(a) an unconditional sale of a financial asset;

(b) a sale of a financial asset together with an option to repurchase the financial

asset at its fair value at the time of repurchase; and

(c) a sale of a financial asset together with a put or call option that is deeply out

of the money (ie an option that is so far out of the money it is highly unlikely

to go into the money before expiry).

B3.2.5 Examples of when an entity has retained substantially all the risks and rewards of

ownership are:

(a) a sale and repurchase transaction where the repurchase price is a fixed price

or the sale price plus a lender’s return;

(b) a securities lending agreement;

(c) a sale of a financial asset together with a total return swap that transfers the

market risk exposure back to the entity;

(d) a sale of a financial asset together with a deep in-the-money put or call

option (ie an option that is so far in the money that it is highly unlikely to go

out of the money before expiry); and

(e) a sale of short-term receivables in which the entity guarantees to compensate

the transferee for credit losses that are likely to occur.

B3.2.6 If an entity determines that as a result of the transfer, it has transferred substantially

all the risks and rewards of ownership of the transferred asset, it does not recognise

the transferred asset again in a future period, unless it reacquires the transferred asset

in a new transaction.

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Evaluation of the transfer of control

B3.2.7 An entity has not retained control of a transferred asset if the transferee has the

practical ability to sell the transferred asset. An entity has retained control of a

transferred asset if the transferee does not have the practical ability to sell the

transferred asset. A transferee has the practical ability to sell the transferred asset if it

is traded in an active market because the transferee could repurchase the transferred

asset in the market if it needs to return the asset to the entity. For example, a

transferee may have the practical ability to sell a transferred asset if the transferred

asset is subject to an option that allows the entity to repurchase it, but the transferee

can readily obtain the transferred asset in the market if the option is exercised. A

transferee does not have the practical ability to sell the transferred asset if the entity

retains such an option and the transferee cannot readily obtain the transferred asset in

the market if the entity exercises its option.

B3.2.8 The transferee has the practical ability to sell the transferred asset only if the

transferee can sell the transferred asset in its entirety to an unrelated third party and is

able to exercise that ability unilaterally and without imposing additional restrictions

on the transfer. The critical question is what the transferee is able to do in practice,

not what contractual rights the transferee has concerning what it can do with the

transferred asset or what contractual prohibitions exist. In particular:

(a) a contractual right to dispose of the transferred asset has little practical effect

if there is no market for the transferred asset, and

(b) an ability to dispose of the transferred asset has little practical effect if it

cannot be exercised freely. For that reason:

(i) the transferee’s ability to dispose of the transferred asset must be

independent of the actions of others (ie it must be a unilateral

ability), and

(ii) the transferee must be able to dispose of the transferred asset without

needing to attach restrictive conditions or ‘strings’ to the transfer (eg

conditions about how a loan asset is serviced or an option giving the

transferee the right to repurchase the asset).

B3.2.9 That the transferee is unlikely to sell the transferred asset does not, of itself, mean

that the transferor has retained control of the transferred asset. However, if a put

option or guarantee constrains the transferee from selling the transferred asset, then

the transferor has retained control of the transferred asset. For example, if a put

option or guarantee is sufficiently valuable it constrains the transferee from selling

the transferred asset because the transferee would, in practice, not sell the transferred

asset to a third party without attaching a similar option or other restrictive conditions.

Instead, the transferee would hold the transferred asset so as to obtain payments

under the guarantee or put option. Under these circumstances the transferor has

retained control of the transferred asset.

Transfers that qualify for derecognition

B3.2.10An entity may retain the right to a part of the interest payments on transferred assets

as compensation for servicing those assets. The part of the interest payments that the

entity would give up upon termination or transfer of the servicing contract is

allocated to the servicing asset or servicing liability. The part of the interest payments

that the entity would not give up is an interest-only strip receivable. For example, if

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the entity would not give up any interest upon termination or transfer of the servicing

contract, the entire interest spread is an interest-only strip receivable. For the

purposes of applying paragraph 3.2.13, the fair values of the servicing asset and

interest-only strip receivable are used to allocate the carrying amount of the

receivable between the part of the asset that is derecognised and the part that

continues to be recognised. If there is no servicing fee specified or the fee to be

received is not expected to compensate the entity adequately for performing the

servicing, a liability for the servicing obligation is recognised at fair value.

B3.2.11 When measuring the fair values of the part that continues to be recognised and the

part that is derecognised for the purposes of applying paragraph 3.2.13, an entity

applies the fair value measurement requirements in NFRS 13 Fair Value

Measurement in addition to paragraph 3.2.14.

Transfers that do not qualify for derecognition

B3.2.12The following is an application of the principle outlined in paragraph 3.2.15. If a

guarantee provided by the entity for default losses on the transferred asset prevents a

transferred asset from being derecognised because the entity has retained

substantially all the risks and rewards of ownership of the transferred asset, the

transferred asset continues to be recognised in its entirety and the consideration

received is recognised as a liability.

Continuing involvement in transferred assets

B3.2.13The following are examples of how an entity measures a transferred asset and the

associated liability under paragraph 3.2.16.

All assets

(a) If a guarantee provided by an entity to pay for default losses on a transferred

asset prevents the transferred asset from being derecognised to the extent of

the continuing involvement, the transferred asset at the date of the transfer is

measured at the lower of (i) the carrying amount of the asset and (ii) the

maximum amount of the consideration received in the transfer that the entity

could be required to repay (‘the guarantee amount’). The associated liability

is initially measured at the guarantee amount plus the fair value of the

guarantee (which is normally the consideration received for the guarantee).

Subsequently, the initial fair value of the guarantee is recognised in profit or

loss when (or as) the obligation is satisfied (in accordance with the principles

of NFRS 15) and the carrying value of the asset is reduced by any loss

allowance.

Assets measured at amortised cost

(b) If a put option obligation written by an entity or call option right held by an

entity prevents a transferred asset from being derecognised and the entity

measures the transferred asset at amortised cost, the associated liability is

measured at its cost (ie the consideration received) adjusted for the

amortisation of any difference between that cost and the gross carrying

amount of the transferred asset at the expiration date of the option. For

example, assume that the gross carrying amount of the asset on the date of

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the transfer is CU98 and that the consideration received is CU95. The gross

carrying amount of the asset on the option exercise date will be CU100. The

initial carrying amount of the associated liability is CU95 and the difference

between CU95 and CU100 is recognised in profit or loss using the effective

interest method. If the option is exercised, any difference between the

carrying amount of the associated liability and the exercise price is


Assets measured at fair value

(c) If a call option right retained by an entity prevents a transferred asset from

being derecognised and the entity measures the transferred asset at fair value,

the asset continues to be measured at its fair value. The associated liability is

measured at (i) the option exercise price less the time value of the option if

the option is in or at the money, or (ii) the fair value of the transferred asset

less the time value of the option if the option is out of the money. The

adjustment to the measurement of the associated liability ensures that the net

carrying amount of the asset and the associated liability is the fair value of

the call option right. For example, if the fair value of the underlying asset is

CU80, the option exercise price is CU95 and the time value of the option is

CU5, the carrying amount of the associated liability is CU75 (CU80 – CU5)

and the carrying amount of the transferred asset is CU80 (ie its fair value).

(d) If a put option written by an entity prevents a transferred asset from being

derecognised and the entity measures the transferred asset at fair value, the

associated liability is measured at the option exercise price plus the time

value of the option. The measurement of the asset at fair value is limited to

the lower of the fair value and the option exercise price because the entity

has no right to increases in the fair value of the transferred asset above the

exercise price of the option. This ensures that the net carrying amount of the

asset and the associated liability is the fair value of the put option obligation.

For example, if the fair value of the underlying asset is CU120, the option

exercise price is CU100 and the time value of the option is CU5, the carrying

amount of the associated liability is CU105 (CU100 + CU5) and the carrying

amount of the asset is CU100 (in this case the option exercise price).

(e) If a collar, in the form of a purchased call and written put, prevents a

transferred asset from being derecognised and the entity measures the asset at

fair value, it continues to measure the asset at fair value. The associated

liability is measured at (i) the sum of the call exercise price and fair value of

the put option less the time value of the call option, if the call option is in or

at the money, or (ii) the sum of the fair value of the asset and the fair value of

the put option less the time value of the call option if the call option is out of

the money. The adjustment to the associated liability ensures that the net

carrying amount of the asset and the associated liability is the fair value of

the options held and written by the entity. For example, assume an entity

transfers a financial asset that is measured at fair value while simultaneously

purchasing a call with an exercise price of CU120 and writing a put with an

exercise price of CU80. Assume also that the fair value of the asset is CU100

at the date of the transfer. The time value of the put and call are CU1 and

CU5 respectively. In this case, the entity recognises an asset of CU100 (the

fair value of the asset) and a liability of CU96 [(CU100 + CU1) – CU5]. This

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gives a net asset value of CU4, which is the fair value of the options held and

written by the entity.

All transfers

B3.2.14To the extent that a transfer of a financial asset does not qualify for derecognition, the

transferor’s contractual rights or obligations related to the transfer are not accounted

for separately as derivatives if recognising both the derivative and either the

transferred asset or the liability arising from the transfer would result in recognising

the same rights or obligations twice. For example, a call option retained by the

transferor may prevent a transfer of financial assets from being accounted for as a

sale. In that case, the call option is not separately recognised as a derivative asset.

B3.2.15To the extent that a transfer of a financial asset does not qualify for derecognition, the

transferee does not recognise the transferred asset as its asset. The transferee

derecognises the cash or other consideration paid and recognises a receivable from

the transferor. If the transferor has both a right and an obligation to reacquire control

of the entire transferred asset for a fixed amount (such as under a repurchase

agreement), the transferee may measure its receivable at amortised cost if it meets the

criteria in paragraph 4.1.2.

Examples

B3.2.16The following examples illustrate the application of the derecognition principles of

this Standard.

(a) Repurchase agreements and securities lending. If a financial asset is sold

under an agreement to repurchase it at a fixed price or at the sale price plus a

lender’s return or if it is loaned under an agreement to return it to the

transferor, it is not derecognised because the transferor retains substantially

all the risks and rewards of ownership. If the transferee obtains the right to

sell or pledge the asset, the transferor reclassifies the asset in its statement of

financial position, for example, as a loaned asset or repurchase receivable.

(b) Repurchase agreements and securities lending—assets that are substantially

the same. If a financial asset is sold under an agreement to repurchase the

same or substantially the same asset at a fixed price or at the sale price plus a

lender’s return or if a financial asset is borrowed or loaned under an

agreement to return the same or substantially the same asset to the transferor,

it is not derecognised because the transferor retains substantially all the risks

and rewards of ownership.

(c) Repurchase agreements and securities lending—right of substitution. If a

repurchase agreement at a fixed repurchase price or a price equal to the sale

price plus a lender’s return, or a similar securities lending transaction,

provides the transferee with a right to substitute assets that are similar and of

equal fair value to the transferred asset at the repurchase date, the asset sold

or lent under a repurchase or securities lending transaction is not

derecognised because the transferor retains substantially all the risks and

rewards of ownership.

(d) Repurchase right of first refusal at fair value. If an entity sells a financial

asset and retains only a right of first refusal to repurchase the transferred

asset at fair value if the transferee subsequently sells it, the entity

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derecognises the asset because it has transferred substantially all the risks and

rewards of ownership.

(e) Wash sale transaction. The repurchase of a financial asset shortly after it has

been sold is sometimes referred to as a wash sale. Such a repurchase does not

preclude derecognition provided that the original transaction met the

derecognition requirements. However, if an agreement to sell a financial

asset is entered into concurrently with an agreement to repurchase the same

asset at a fixed price or the sale price plus a lender’s return, then the asset is

not derecognised.

(f) Put options and call options that are deeply in the money. If a transferred

financial asset can be called back by the transferor and the call option is

deeply in the money, the transfer does not qualify for derecognition because

the transferor has retained substantially all the risks and rewards of

ownership. Similarly, if the financial asset can be put back by the transferee

and the put option is deeply in the money, the transfer does not qualify for

derecognition because the transferor has retained substantially all the risks


(g) Put options and call options that are deeply out of the money. A financial

asset that is transferred subject only to a deep out-of-the-money put option

held by the transferee or a deep out-of-the-money call option held by the

transferor is derecognised. This is because the transferor has transferred

substantially all the risks and rewards of ownership.

(h) Readily obtainable assets subject to a call option that is neither deeply in the

money nor deeply out of the money. If an entity holds a call option on an

asset that is readily obtainable in the market and the option is neither deeply

in the money nor deeply out of the money, the asset is derecognised. This is

because the entity (i) has neither retained nor transferred substantially all the

risks and rewards of ownership, and (ii) has not retained control. However, if

the asset is not readily obtainable in the market, derecognition is precluded to

the extent of the amount of the asset that is subject to the call option because

the entity has retained control of the asset.

(i) A not readily obtainable asset subject to a put option written by an entity that

is neither deeply in the money nor deeply out of the money . If an entity

transfers a financial asset that is not readily obtainable in the market, and

writes a put option that is not deeply out of the money, the entity neither

retains nor transfers substantially all the risks and rewards of ownership

because of the written put option. The entity retains control of the asset if the

put option is sufficiently valuable to prevent the transferee from selling the

asset, in which case the asset continues to be recognised to the extent of the

transferor’s continuing involvement (see paragraph B3.2.9). The entity

transfers control of the asset if the put option is not sufficiently valuable to

prevent the transferee from selling the asset, in which case the asset is

derecognised.

(j) Assets subject to a fair value put or call option or a forward repurchase

agreement. A transfer of a financial asset that is subject only to a put or call

option or a forward repurchase agreement that has an exercise or repurchase

price equal to the fair value of the financial asset at the time of repurchase

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results in derecognition because of the transfer of substantially all the risks


(k) Cash-settled call or put options. An entity evaluates the transfer of a financial

asset that is subject to a put or call option or a forward repurchase agreement

that will be settled net in cash to determine whether it has retained or

transferred substantially all the risks and rewards of ownership. If the entity

has not retained substantially all the risks and rewards of ownership of the

transferred asset, it determines whether it has retained control of the

transferred asset. That the put or the call or the forward repurchase agreement

is settled net in cash does not automatically mean that the entity has

transferred control (see paragraphs B3.2.9 and (g), (h) and (i) above).

(l) Removal of accounts provision. A removal of accounts provision is an

unconditional repurchase (call) option that gives an entity the right to reclaim

assets transferred subject to some restrictions. Provided that such an option

results in the entity neither retaining nor transferring substantially all the

risks and rewards of ownership, it precludes derecognition only to the extent

of the amount subject to repurchase (assuming that the transferee cannot sell

the assets). For example, if the carrying amount and proceeds from the

transfer of loan assets are CU100,000 and any individual loan could be called

back but the aggregate amount of loans that could be repurchased could not

exceed CU10,000, CU90,000 of the loans would qualify for derecognition.

(m) Clean-up calls. An entity, which may be a transferor, that services transferred

assets may hold a clean-up call to purchase remaining transferred assets

when the amount of outstanding assets falls to a specified level at which the

cost of servicing those assets becomes burdensome in relation to the benefits

of servicing. Provided that such a clean-up call results in the entity neither

retaining nor transferring substantially all the risks and rewards of ownership

and the transferee cannot sell the assets, it precludes derecognition only to

the extent of the amount of the assets that is subject to the call option.

(n) Subordinated retained interests and credit guarantees . An entity may provide

the transferee with credit enhancement by subordinating some or all of its

interest retained in the transferred asset. Alternatively, an entity may provide

the transferee with credit enhancement in the form of a credit guarantee that

could be unlimited or limited to a specified amount. If the entity retains

substantially all the risks and rewards of ownership of the transferred asset,

the asset continues to be recognised in its entirety. If the entity retains some,

but not substantially all, of the risks and rewards of ownership and has

retained control, derecognition is precluded to the extent of the amount of

cash or other assets that the entity could be required to pay.

(o) Total return swaps. An entity may sell a financial asset to a transferee and

enter into a total return swap with the transferee, whereby all of the interest

payment cash flows from the underlying asset are remitted to the entity in

exchange for a fixed payment or variable rate payment and any increases or

declines in the fair value of the underlying asset are absorbed by the entity. In

such a case, derecognition of all of the asset is prohibited.

(p) Interest rate swaps. An entity may transfer to a transferee a fixed rate

financial asset and enter into an interest rate swap with the transferee to

receive a fixed interest rate and pay a variable interest rate based on a

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notional amount that is equal to the principal amount of the transferred

financial asset. The interest rate swap does not preclude derecognition of the

transferred asset provided the payments on the swap are not conditional on

payments being made on the transferred asset.

(q) Amortising interest rate swaps. An entity may transfer to a transferee a fixed

rate financial asset that is paid off over time, and enter into an amortising

interest rate swap with the transferee to receive a fixed interest rate and pay a

variable interest rate based on a notional amount. If the notional amount of

the swap amortises so that it equals the principal amount of the transferred

financial asset outstanding at any point in time, the swap would generally

result in the entity retaining substantial prepayment risk, in which case the

entity either continues to recognise all of the transferred asset or continues to

recognise the transferred asset to the extent of its continuing involvement.

Conversely, if the amortisation of the notional amount of the swap is not

linked to the principal amount outstanding of the transferred asset, such a

swap would not result in the entity retaining prepayment risk on the asset.

Hence, it would not preclude derecognition of the transferred asset provided

the payments on the swap are not conditional on interest payments being

made on the transferred asset and the swap does not result in the entity

retaining any other significant risks and rewards of ownership on the

transferred asset.

(r) Write-off. An entity has no reasonable expectations of recovering the

contractual cash flows on a financial asset in its entirety or a portion thereof.

B3.2.17This paragraph illustrates the application of the continuing involvement approach

when the entity’s continuing involvement is in a part of a financial asset.

Assume an entity has a portfolio of prepayable loans whose coupon and effective

interest rate is 10 per cent and whose principal amount and amortised cost is

CU10,000. It enters into a transaction in which, in return for a payment of

CU9,115, the transferee obtains the right to CU9,000 of any collections of principal

plus interest thereon at 9.5 per cent. The entity retains rights to CU1,000 of any

collections of principal plus interest thereon at 10 per cent, plus the excess spread

of 0.5 per cent on the remaining CU9,000 of principal. Collections from

prepayments are allocated between the entity and the transferee proportionately in

the ratio of 1:9, but any defaults are deducted from the entity’s interest of CU1,000

until that interest is exhausted. The fair value of the loans at the date of the

transaction is CU10,100 and the fair value of the excess spread of 0.5 per cent is

CU40.

The entity determines that it has transferred some significant risks and rewards of

ownership (for example, significant prepayment risk) but has also retained some

significant risks and rewards of ownership (because of its subordinated retained

interest) and has retained control. It therefore applies the continuing involvement

approach.

To apply this Standard, the entity analyses the transaction as (a) a retention of a

fully proportionate retained interest of CU1,000, plus (b) the subordination of that

retained interest to provide credit enhancement to the transferee for credit losses.

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The entity calculates that CU9,090 (90% × CU10,100) of the consideration

received of CU9,115 represents the consideration for a fully proportionate 90 per

cent share. The remainder of the consideration received (CU25) represents

consideration received for subordinating its retained interest to provide credit

enhancement to the transferee for credit losses. In addition, the excess spread of 0.5

per cent represents consideration received for the credit enhancement. Accordingly,

the total consideration received for the credit enhancement is CU65 (CU25 +

CU40).

The entity calculates the gain or loss on the sale of the 90 per cent share of cash

flows. Assuming that separate fair values of the 90 per cent part transferred and the

10 per cent part retained are not available at the date of the transfer, the entity

allocates the carrying amount of the asset in accordance with paragraph 3.2.14 of

NFRS 9 as follows:

Fair value Percentage Allocatedcarryingamount

Portion transferred 9,090 90% 9,000

Portion retained 1,010 10% 1,000

Total 10,100 10,000

The entity computes its gain or loss on the sale of the 90 per cent share of the cash

flows by deducting the allocated carrying amount of the portion transferred from

the consideration received, ie CU90 (CU9,090 – CU9,000). The carrying amount

of the portion retained by the entity is CU1,000.

In addition, the entity recognises the continuing involvement that results from the

subordination of its retained interest for credit losses. Accordingly, it recognises an

asset of CU1,000 (the maximum amount of the cash flows it would not receive

under the subordination), and an associated liability of CU1,065 (which is the

maximum amount of the cash flows it would not receive under the subordination,

ie CU1,000 plus the fair value of the subordination of CU65).

The entity uses all of the above information to account for the transaction as

follows:

Debit Credit

Original asset — 9,000

Asset recognised for subordination or the residual interest 1,000 —

Asset for the consideration received inthe form of excess spread 40 —

Profit or loss (gain on transfer) — 90

Liability — 1,065

Cash received 9,115 —

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Total 10,155 10,155

Immediately following the transaction, the carrying amount of the asset is CU2,040

comprising CU1,000, representing the allocated cost of the portion retained, and

CU1,040, representing the entity’s additional continuing involvement from the

subordination of its retained interest for credit losses (which includes the excess

spread of CU40).

In subsequent periods, the entity recognises the consideration received for the

credit enhancement (CU65) on a time proportion basis, accrues interest on the

recognised asset using the effective interest method and recognises any impairment

losses on the recognised assets. As an example of the latter, assume that in the

following year there is an impairment loss on the underlying loans of CU300. The

entity reduces its recognised asset by CU600 (CU300 relating to its retained

interest and CU300 relating to the additional continuing involvement that arises

from the subordination of its retained interest for impairment losses), and reduces

its recognised liability by CU300. The net result is a charge to profit or loss for

impairment losses of CU300.

Derecognition of financial liabilities (Section 3.3)

B3.3.1 A financial liability (or part of it) is extinguished when the debtor either:

(a) discharges the liability (or part of it) by paying the creditor, normally with

cash, other financial assets, goods or services; or

(b) is legally released from primary responsibility for the liability (or part of it)

either by process of law or by the creditor. (If the debtor has given a

guarantee this condition may still be met.)

B3.3.2 If an issuer of a debt instrument repurchases that instrument, the debt is extinguished

even if the issuer is a market maker in that instrument or intends to resell it in the

near term.

B3.3.3 Payment to a third party, including a trust (sometimes called ‘in-substance

defeasance’), does not, by itself, relieve the debtor of its primary obligation to the

creditor, in the absence of legal release.

B3.3.4 If a debtor pays a third party to assume an obligation and notifies its creditor that the

third party has assumed its debt obligation, the debtor does not derecognise the debt

obligation unless the condition in paragraph B3.3.1(b) is met. If the debtor pays a

third party to assume an obligation and obtains a legal release from its creditor, the

debtor has extinguished the debt. However, if the debtor agrees to make payments on

the debt to the third party or direct to its original creditor, the debtor recognises a new

debt obligation to the third party.

B3.3.5 Although legal release, whether judicially or by the creditor, results in derecognition

of a liability, the entity may recognise a new liability if the derecognition criteria in

paragraphs 3.2.1–3.2.23 are not met for the financial assets transferred. If those

criteria are not met, the transferred assets are not derecognised, and the entity

recognises a new liability relating to the transferred assets.

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B3.3.6 For the purpose of paragraph 3.3.2, the terms are substantially different if the

discounted present value of the cash flows under the new terms, including any fees

paid net of any fees received and discounted using the original effective interest rate,

is at least 10 per cent different from the discounted present value of the remaining

cash flows of the original financial liability. If an exchange of debt instruments or

modification of terms is accounted for as an extinguishment, any costs or fees

incurred are recognised as part of the gain or loss on the extinguishment. If the

exchange or modification is not accounted for as an extinguishment, any costs or fees

incurred adjust the carrying amount of the liability and are amortised over the

remaining term of the modified liability.

B3.3.7 In some cases, a creditor releases a debtor from its present obligation to make

payments, but the debtor assumes a guarantee obligation to pay if the party assuming

primary responsibility defaults. In these circumstances the debtor:

(a) recognises a new financial liability based on the fair value of its obligation

for the guarantee, and

(b) recognises a gain or loss based on the difference between (i) any proceeds

paid and (ii) the carrying amount of the original financial liability less the fair

value of the new financial liability.

Classification (Chapter 4)

Classification of financial assets (Section 4.1)

The entity’s business model for managing financial assets

B4.1.1 Paragraph 4.1.1(a) requires an entity to classify financial assets on the basis of the

entity’s business model for managing the financial assets, unless paragraph 4.1.5

applies. An entity assesses whether its financial assets meet the condition in

paragraph 4.1.2(a) or the condition in paragraph 4.1.2A(a) on the basis of the

business model as determined by the entity’s key management personnel (as defined

in NAS 24 Related Party Disclosures).

B4.1.2 An entity’s business model is determined at a level that reflects how groups of

financial assets are managed together to achieve a particular business objective. The

entity’s business model does not depend on management’s intentions for an

individual instrument. Accordingly, this condition is not an instrument-by-instrument

approach to classification and should be determined on a higher level of aggregation.

However, a single entity may have more than one business model for managing its

financial instruments. Consequently, classification need not be determined at the

reporting entity level. For example, an entity may hold a portfolio of investments that

it manages in order to collect contractual cash flows and another portfolio of

investments that it manages in order to trade to realise fair value changes. Similarly,

in some circumstances, it may be appropriate to separate a portfolio of financial

assets into subportfolios in order to reflect the level at which an entity manages those

financial assets. For example, that may be the case if an entity originates or purchases

a portfolio of mortgage loans and manages some of the loans with an objective of

collecting contractual cash flows and manages the other loans with an objective of

selling them.

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B4.1.2A An entity’s business model refers to how an entity manages its financial assets

in order to generate cash flows. That is, the entity’s business model determines

whether cash flows will result from collecting contractual cash flows, selling

financial assets or both. Consequently, this assessment is not performed on the basis

of scenarios that the entity does not reasonably expect to occur, such as so-called

‘worst case’ or ‘stress case’ scenarios. For example, if an entity expects that it will

sell a particular portfolio of financial assets only in a stress case scenario, that

scenario would not affect the entity’s assessment of the business model for those

assets if the entity reasonably expects that such a scenario will not occur. If cash

flows are realised in a way that is different from the entity’s expectations at the date

that the entity assessed the business model (for example, if the entity sells more or

fewer financial assets than it expected when it classified the assets), that does not

give rise to a prior period error in the entity’s financial statements (see NAS 8

Accounting Policies, Changes in Accounting Estimates and Errors) nor does it

change the classification of the remaining financial assets held in that business model

(ie those assets that the entity recognised in prior periods and still holds) as long as

the entity considered all relevant information that was available at the time that it

made the business model assessment. However, when an entity assesses the business

model for newly originated or newly purchased financial assets, it must consider

information about how cash flows were realised in the past, along with all other

relevant information.

B4.1.2B An entity’s business model for managing financial assets is a matter of fact

and not merely an assertion. It is typically observable through the activities that the

entity undertakes to achieve the objective of the business model. An entity will need

to use judgement when it assesses its business model for managing financial assets

and that assessment is not determined by a single factor or activity. Instead, the entity

must consider all relevant evidence that is available at the date of the assessment.

Such relevant evidence includes, but is not limited to:

(a) how the performance of the business model and the financial assets held

within that business model are evaluated and reported to the entity’s key

management personnel;

(b) the risks that affect the performance of the business model (and the financial

assets held within that business model) and, in particular, the way in which

those risks are managed; and

(c) how managers of the business are compensated (for example, whether the

compensation is based on the fair value of the assets managed or on the

contractual cash flows collected).

A business model whose objective is to hold assets in order to collect contractual cash flows

B4.1.2C Financial assets that are held within a business model whose objective is to

hold assets in order to collect contractual cash flows are managed to realise cash

flows by collecting contractual payments over the life of the instrument. That is, the

entity manages the assets held within the portfolio to collect those particular

contractual cash flows (instead of managing the overall return on the portfolio by

both holding and selling assets). In determining whether cash flows are going to be

realised by collecting the financial assets’ contractual cash flows, it is necessary to

consider the frequency, value and timing of sales in prior periods, the reasons for

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those sales and expectations about future sales activity. However sales in themselves

do not determine the business model and therefore cannot be considered in isolation.

Instead, information about past sales and expectations about future sales provide

evidence related to how the entity’s stated objective for managing the financial assets

is achieved and, specifically, how cash flows are realised. An entity must consider

information about past sales within the context of the reasons for those sales and the

conditions that existed at that time as compared to current conditions.

B4.1.3 Although the objective of an entity’s business model may be to hold financial assets

in order to collect contractual cash flows, the entity need not hold all of those

instruments until maturity. Thus an entity’s business model can be to hold financial

assets to collect contractual cash flows even when sales of financial assets occur or

are expected to occur in the future.

B4.1.3A The business model may be to hold assets to collect contractual cash flows

even if the entity sells financial assets when there is an increase in the assets’ credit

risk. To determine whether there has been an increase in the assets’ credit risk, the

entity considers reasonable and supportable information, including forward looking

information. Irrespective of their frequency and value, sales due to an increase in the

assets’ credit risk are not inconsistent with a business model whose objective is to

hold financial assets to collect contractual cash flows because the credit quality of

financial assets is relevant to the entity’s ability to collect contractual cash flows.

Credit risk management activities that are aimed at minimising potential credit losses

due to credit deterioration are integral to such a business model. Selling a financial

asset because it no longer meets the credit criteria specified in the entity’s

documented investment policy is an example of a sale that has occurred due to an

increase in credit risk. However, in the absence of such a policy, the entity may

demonstrate in other ways that the sale occurred due to an increase in credit risk.

B4.1.3B Sales that occur for other reasons, such as sales made to manage credit

concentration risk (without an increase in the assets’ credit risk), may also be

consistent with a business model whose objective is to hold financial assets in order

to collect contractual cash flows. In particular, such sales may be consistent with a

business model whose objective is to hold financial assets in order to collect

contractual cash flows if those sales are infrequent (even if significant in value) or

insignificant in value both individually and in aggregate (even if frequent). If more

than an infrequent number of such sales are made out of a portfolio and those sales

are more than insignificant in value (either individually or in aggregate), the entity

needs to assess whether and how such sales are consistent with an objective of

collecting contractual cash flows. Whether a third party imposes the requirement to

sell the financial assets, or that activity is at the entity’s discretion, is not relevant to

this assessment. An increase in the frequency or value of sales in a particular period

is not necessarily inconsistent with an objective to hold financial assets in order to

collect contractual cash flows, if an entity can explain the reasons for those sales and

demonstrate why those sales do not reflect a change in the entity’s business model. In

addition, sales may be consistent with the objective of holding financial assets in

order to collect contractual cash flows if the sales are made close to the maturity of

the financial assets and the proceeds from the sales approximate the collection of the

remaining contractual cash flows.

B4.1.4 The following are examples of when the objective of an entity’s business model may

be to hold financial assets to collect the contractual cash flows. This list of examples

is not exhaustive. Furthermore, the examples are not intended to discuss all factors

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that may be relevant to the assessment of the entity’s business model nor specify the

relative importance of the factors.

Example Analysis

Example 1

An entity holds investments to

collect their contractual cash flows.

The funding needs of the entity are

predictable and the maturity of its

financial assets is matched to the

entity’s estimated funding needs.

The entity performs credit risk

management activities with the

objective of minimising credit

losses. In the past, sales have

typically occurred when the

financial assets’ credit risk has

increased such that the assets no

longer meet the credit criteria

specified in the entity’s documented

investment policy. In addition,

infrequent sales have occurred as a

result of unanticipated funding

needs.

Reports to key management

personnel focus on the credit

quality of the financial assets and

the contractual return. The entity

also monitors fair values of the

financial assets, among other

information.

Although the entity considers, among other

information, the financial assets’ fair values

from a liquidity perspective (ie the cash

amount that would be realised if the entity

needs to sell assets), the entity’s objective is

to hold the financial assets in order to collect

the contractual cash flows. Sales would not

contradict that objective if they were in

response to an increase in the assets’ credit

risk, for example if the assets no longer meet

the credit criteria specified in the entity’s

documented investment policy. Infrequent

sales resulting from unanticipated funding

needs (eg in a stress case scenario) also

would not contradict that objective, even if

such sales are significant in value.

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Example Analysis

Example 2

An entity’s business model is to

purchase portfolios of financial

assets, such as loans. Those

portfolios may or may not include

financial assets that are credit

impaired.

If payment on the loans is not made

on a timely basis, the entity

attempts to realise the contractual

cash flows through various means

—for example, by contacting the

debtor by mail, telephone or other

methods. The entity’s objective is to

collect the contractual cash flows

and the entity does not manage any

of the loans in this portfolio with an

objective of realising cash flows by

selling them.

In some cases, the entity enters into

interest rate swaps to change the

interest rate on particular financial

assets in a portfolio from a floating

interest rate to a fixed interest rate.

The objective of the entity’s business model

is to hold the financial assets in order to

collect the contractual cash flows.

The same analysis would apply even if the

entity does not expect to receive all of the

contractual cash flows (eg some of the

financial assets are credit impaired at initial

recognition).

Moreover, the fact that the entity enters into

derivatives to modify the cash flows of the

portfolio does not in itself change the

entity’s business model.

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Example Analysis

Example 3

An entity has a business model with

the objective of originating loans to

customers and subsequently selling

those loans to a securitisation

vehicle. The securitisation vehicle

issues instruments to investors.

The originating entity controls the

securitisation vehicle and thus

consolidates it.

The securitisation vehicle collects

the contractual cash flows from the

loans and passes them on to its

investors.

It is assumed for the purposes of

this example that the loans continue

to be recognised in the consolidated

statement of financial position

because they are not derecognised

by the securitisation vehicle.

The consolidated group originated the loans

with the objective of holding them to collect

the contractual cash flows.

However, the originating entity has an

objective of realising cash flows on the loan

portfolio by selling the loans to the

securitisation vehicle, so for the purposes of

its separate financial statements it would not

be considered to be managing this portfolio

in order to collect the contractual cash flows.

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Example Analysis

Example 4

A financial institution holds

financial assets to meet liquidity

needs in a ‘stress case’ scenario (eg,

a run on the bank’s deposits). The

entity does not anticipate selling

these assets except in such

scenarios.

The entity monitors the credit

quality of the financial assets and

its objective in managing the

financial assets is to collect the

contractual cash flows. The entity

evaluates the performance of the

assets on the basis of interest

revenue earned and credit losses

realised.

However, the entity also monitors

the fair value of the financial assets

from a liquidity perspective to

ensure that the cash amount that

would be realised if the entity

needed to sell the assets in a stress

case scenario would be sufficient to

meet the entity’s liquidity needs.

Periodically, the entity makes sales

that are insignificant in value to

demonstrate liquidity.

The objective of the entity’s business model

is to hold the financial assets to collect

contractual cash flows.

The analysis would not change even if

during a previous stress case scenario the

entity had sales that were significant in value

in order to meet its liquidity needs.

Similarly, recurring sales activity that is

insignificant in value is not inconsistent with

holding financial assets to collect contractual

cash flows.

In contrast, if an entity holds financial assets

to meet its everyday liquidity needs and

meeting that objective involves frequent

sales that are significant in value, the

objective of the entity’s business model is

not to hold the financial assets to collect

contractual cash flows.

Similarly, if the entity is required by its

regulator to routinely sell financial assets to

demonstrate that the assets are liquid, and

the value of the assets sold is significant, the

entity’s business model is not to hold

financial assets to collect contractual cash

flows. Whether a third party imposes the

requirement to sell the financial assets, or

that activity is at the entity’s discretion, is

not relevant to the analysis.

A business model whose objective is achieved by both collecting contractual cash flows and selling financial assets

B4.1.4A An entity may hold financial assets in a business model whose objective is

achieved by both collecting contractual cash flows and selling financial assets. In this

type of business model, the entity’s key management personnel have made a decision

that both collecting contractual cash flows and selling financial assets are integral to

achieving the objective of the business model. There are various objectives that may

be consistent with this type of business model. For example, the objective of the

business model may be to manage everyday liquidity needs, to maintain a particular

interest yield profile or to match the duration of the financial assets to the duration of

the liabilities that those assets are funding. To achieve such an objective, the entity

will both collect contractual cash flows and sell financial assets.

B4.1.4B Compared to a business model whose objective is to hold financial assets to

collect contractual cash flows, this business model will typically involve greater

frequency and value of sales. This is because selling financial assets is integral to

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achieving the business model's objective instead of being only incidental to it.

However, there is no threshold for the frequency or value of sales that must occur in

this business model because both collecting contractual cash flows and selling

financial assets are integral to achieving its objective.

B4.1.4C The following are examples of when the objective of the entity’s business

model may be achieved by both collecting contractual cash flows and selling

financial assets. This list of examples is not exhaustive. Furthermore, the examples

are not intended to describe all the factors that may be relevant to the assessment of

the entity’s business model nor specify the relative importance of the factors.

Example Analysis

Example 5

An entity anticipates capital

expenditure in a few years. The

entity invests its excess cash in

short and long-term financial assets

so that it can fund the expenditure

when the need arises. Many of the

financial assets have contractual

lives that exceed the entity’s

anticipated investment period.

The entity will hold financial assets

to collect the contractual cash flows

and, when an opportunity arises, it

will sell financial assets to re-invest

the cash in financial assets with a

higher return.

The managers responsible for the

portfolio are remunerated based on

the overall return generated by the

portfolio.

The objective of the business model is

achieved by both collecting contractual cash

flows and selling financial assets. The entity

will make decisions on an ongoing basis

about whether collecting contractual cash

flows or selling financial assets will

maximise the return on the portfolio until the

need arises for the invested cash.

In contrast, consider an entity that

anticipates a cash outflow in five years to

fund capital expenditure and invests excess

cash in short-term financial assets. When the

investments mature, the entity reinvests the

cash in new short-term financial assets. The

entity maintains this strategy until the funds

are needed, at which time the entity uses the

proceeds from the maturing financial assets

to fund the capital expenditure. Only sales

that are insignificant in value occur before

maturity (unless there is an increase in credit

risk). The objective of this contrasting

business model is to hold financial assets to

collect contractual cash flows.

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Example Analysis

Example 6

A financial institution holds

financial assets to meet its everyday

liquidity needs. The entity seeks to

minimise the costs of managing

those liquidity needs and therefore

actively manages the return on the

portfolio. That return consists of

collecting contractual payments as

well as gains and losses from the

sale of financial assets.

As a result, the entity holds

financial assets to collect

contractual cash flows and sells

financial assets to reinvest in higher

yielding financial assets or to better

match the duration of its liabilities.

In the past, this strategy has

resulted in frequent sales activity

and such sales have been significant

in value. This activity is expected to

continue in the future.

The objective of the business model is to

maximise the return on the portfolio to meet

everyday liquidity needs and the entity

achieves that objective by both collecting

contractual cash flows and selling financial

assets. In other words, both collecting

contractual cash flows and selling financial

assets are integral to achieving the business

model’s objective.

Example 7

An insurer holds financial assets in

order to fund insurance contract

liabilities. The insurer uses the

proceeds from the contractual cash

flows on the financial assets to

settle insurance contract liabilities

as they come due. To ensure that

the contractual cash flows from the

financial assets are sufficient to

settle those liabilities, the insurer

undertakes significant buying and

selling activity on a regular basis to

rebalance its portfolio of assets and

to meet cash flow needs as they

arise.

The objective of the business model is to

fund the insurance contract liabilities. To

achieve this objective, the entity collects

contractual cash flows as they come due and

sells financial assets to maintain the desired

profile of the asset portfolio. Thus both

collecting contractual cash flows and selling

financial assets are integral to achieving the

business model’s objective.

Other business models

B4.1.5 Financial assets are measured at fair value through profit or loss if they are not held

within a business model whose objective is to hold assets to collect contractual cash

flows or within a business model whose objective is achieved by both collecting

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contractual cash flows and selling financial assets (but see also paragraph 5.7.5). One

business model that results in measurement at fair value through profit or loss is one

in which an entity manages the financial assets with the objective of realising cash

flows through the sale of the assets. The entity makes decisions based on the assets’

fair values and manages the assets to realise those fair values. In this case, the entity’s

objective will typically result in active buying and selling. Even though the entity

will collect contractual cash flows while it holds the financial assets, the objective of

such a business model is not achieved by both collecting contractual cash flows and

selling financial assets. This is because the collection of contractual cash flows is not

integral to achieving the business model’s objective; instead, it is incidental to it.

B4.1.6 A portfolio of financial assets that is managed and whose performance is evaluated

on a fair value basis (as described in paragraph 4.2.2(b)) is neither held to collect

contractual cash flows nor held both to collect contractual cash flows and to sell

financial assets. The entity is primarily focused on fair value information and uses

that information to assess the assets’ performance and to make decisions. In addition,

a portfolio of financial assets that meets the definition of held for trading is not held

to collect contractual cash flows or held both to collect contractual cash flows and to

sell financial assets. For such portfolios, the collection of contractual cash flows is

only incidental to achieving the business model’s objective. Consequently, such

portfolios of financial assets must be measured at fair value through profit or loss.

Contractual cash flows that are solely payments of principal and interest on the principal amount outstanding

B4.1.7 Paragraph 4.1.1(b) requires an entity to classify a financial asset on the basis of its

contractual cash flow characteristics if the financial asset is held within a business

model whose objective is to hold assets to collect contractual cash flows or within a

business model whose objective is achieved by both collecting contractual cash flows

and selling financial assets, unless paragraph 4.1.5 applies. To do so, the condition in

paragraphs 4.1.2(b) and 4.1.2A(b) requires an entity to determine whether the asset’s

contractual cash flows are solely payments of principal and interest on the principal

amount outstanding.

B4.1.7A Contractual cash flows that are solely payments of principal and interest on the

principal amount outstanding are consistent with a basic lending arrangement. In a

basic lending arrangement, consideration for the time value of money (see paragraphs

B4.1.9A–B4.1.9E) and credit risk are typically the most significant elements of

interest. However, in such an arrangement, interest can also include consideration for

other basic lending risks (for example, liquidity risk) and costs (for example,

administrative costs) associated with holding the financial asset for a particular

period of time. In addition, interest can include a profit margin that is consistent with

a basic lending arrangement. In extreme economic circumstances, interest can be

negative if, for example, the holder of a financial asset either explicitly or implicitly

pays for the deposit of its money for a particular period of time (and that fee exceeds

the consideration that the holder receives for the time value of money, credit risk and

other basic lending risks and costs). However, contractual terms that introduce

exposure to risks or volatility in the contractual cash flows that is unrelated to a basic

lending arrangement, such as exposure to changes in equity prices or commodity

prices, do not give rise to contractual cash flows that are solely payments of principal

and interest on the principal amount outstanding. An originated or a purchased

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financial asset can be a basic lending arrangement irrespective of whether it is a loan

in its legal form.

B4.1.7B In accordance with paragraph 4.1.3(a), principal is the fair value of the

financial asset at initial recognition. However that principal amount may change over

the life of the financial asset (for example, if there are repayments of principal).

B4.1.8 An entity shall assess whether contractual cash flows are solely payments of principal

and interest on the principal amount outstanding for the currency in which the

financial asset is denominated.

B4.1.9 Leverage is a contractual cash flow characteristic of some financial assets. Leverage

increases the variability of the contractual cash flows with the result that they do not

have the economic characteristics of interest. Stand-alone option, forward and swap

contracts are examples of financial assets that include such leverage. Thus, such

contracts do not meet the condition in paragraphs 4.1.2(b) and 4.1.2A(b) and cannot

be subsequently measured at amortised cost or fair value through other

comprehensive income.

Consideration for the time value of money

B4.1.9A Time value of money is the element of interest that provides consideration for

only the passage of time. That is, the time value of money element does not provide

consideration for other risks or costs associated with holding the financial asset. In

order to assess whether the element provides consideration for only the passage of

time, an entity applies judgement and considers relevant factors such as the currency

in which the financial asset is denominated and the period for which the interest rate

is set.

B4.1.9B However, in some cases, the time value of money element may be modified (ie

imperfect). That would be the case, for example, if a financial asset’s interest rate is

periodically reset but the frequency of that reset does not match the tenor of the

interest rate (for example, the interest rate resets every month to a one-year rate) or if

a financial asset’s interest rate is periodically reset to an average of particular short-

and long-term interest rates. In such cases, an entity must assess the modification to

determine whether the contractual cash flows represent solely payments of principal

and interest on the principal amount outstanding. In some circumstances, the entity

may be able to make that determination by performing a qualitative assessment of the

time value of money element whereas, in other circumstances, it may be necessary to

perform a quantitative assessment.

B4.1.9C When assessing a modified time value of money element, the objective is to

determine how different the contractual (undiscounted) cash flows could be from the

(undiscounted) cash flows that would arise if the time value of money element was

not modified (the benchmark cash flows). For example, if the financial asset under

assessment contains a variable interest rate that is reset every month to a one-year

interest rate, the entity would compare that financial asset to a financial instrument

with identical contractual terms and the identical credit risk except the variable

interest rate is reset monthly to a one-month interest rate. If the modified time value

of money element could result in contractual (undiscounted) cash flows that are

significantly different from the (undiscounted) benchmark cash flows, the financial

asset does not meet the condition in paragraphs 4.1.2(b) and 4.1.2A(b). To make this

determination, the entity must consider the effect of the modified time value of

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money element in each reporting period and cumulatively over the life of the

financial instrument. The reason for the interest rate being set in this way is not

relevant to the analysis. If it is clear, with little or no analysis, whether the contractual

(undiscounted) cash flows on the financial asset under the assessment could (or could

not) be significantly different from the (undiscounted) benchmark cash flows, an

entity need not perform a detailed assessment.

B4.1.9D When assessing a modified time value of money element, an entity must

consider factors that could affect future contractual cash flows. For example, if an

entity is assessing a bond with a five-year term and the variable interest rate is reset

every six months to a five-year rate, the entity cannot conclude that the contractual

cash flows are solely payments of principal and interest on the principal amount

outstanding simply because the interest rate curve at the time of the assessment is

such that the difference between a five-year interest rate and a six-month interest rate

is not significant. Instead, the entity must also consider whether the relationship

between the five-year interest rate and the six-month interest rate could change over

the life of the instrument such that the contractual (undiscounted) cash flows over the

life of the instrument could be significantly different from the (undiscounted)

benchmark cash flows. However, an entity must consider only reasonably possible

scenarios instead of every possible scenario. If an entity concludes that the

contractual (undiscounted) cash flows could be significantly different from the

(undiscounted) benchmark cash flows, the financial asset does not meet the condition

in paragraphs 4.1.2(b) and 4.1.2A(b) and therefore cannot be measured at amortised

cost or fair value through other comprehensive income.

B4.1.9E In some jurisdictions, the government or a regulatory authority sets interest

rates. For example, such government regulation of interest rates may be part of a

broad macroeconomic policy or it may be introduced to encourage entities to invest

in a particular sector of the economy. In some of these cases, the objective of the time

value of money element is not to provide consideration for only the passage of time.

However, despite paragraphs B4.1.9A–B4.1.9D, a regulated interest rate shall be

considered a proxy for the time value of money element for the purpose of applying

the condition in paragraphs 4.1.2(b) and 4.1.2A(b) if that regulated interest rate

provides consideration that is broadly consistent with the passage of time and does

not provide exposure to risks or volatility in the contractual cash flows that are

inconsistent with a basic lending arrangement.

Contractual terms that change the timing or amount of contractual cash flows

B4.1.10If a financial asset contains a contractual term that could change the timing or amount

of contractual cash flows (for example, if the asset can be prepaid before maturity or

its term can be extended), the entity must determine whether the contractual cash

flows that could arise over the life of the instrument due to that contractual term are

solely payments of principal and interest on the principal amount outstanding. To

make this determination, the entity must assess the contractual cash flows that could

arise both before, and after, the change in contractual cash flows. The entity may also

need to assess the nature of any contingent event (ie the trigger) that would change

the timing or amount of the contractual cash flows. While the nature of the contingent

event in itself is not a determinative factor in assessing whether the contractual cash

flows are solely payments of principal and interest, it may be an indicator. For

example, compare a financial instrument with an interest rate that is reset to a higher

rate if the debtor misses a particular number of payments to a financial instrument

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with an interest rate that is reset to a higher rate if a specified equity index reaches a

particular level. It is more likely in the former case that the contractual cash flows

over the life of the instrument will be solely payments of principal and interest on the

principal amount outstanding because of the relationship between missed payments

and an increase in credit risk. (See also paragraph B4.1.18.)

B4.1.11 The following are examples of contractual terms that result in contractual cash flows

that are solely payments of principal and interest on the principal amount

outstanding:

(a) a variable interest rate that consists of consideration for the time value of

money, the credit risk associated with the principal amount outstanding

during a particular period of time (the consideration for credit risk may be

determined at initial recognition only, and so may be fixed) and other basic

lending risks and costs, as well as a profit margin;

(b) a contractual term that permits the issuer (ie the debtor) to prepay a debt

instrument or permits the holder (ie the creditor) to put a debt instrument

back to the issuer before maturity and the prepayment amount substantially

represents unpaid amounts of principal and interest on the principal amount

outstanding, which may include reasonable compensation for the early

termination of the contract; and

(c) a contractual term that permits the issuer or the holder to extend the

contractual term of a debt instrument (ie an extension option) and the terms

of the extension option result in contractual cash flows during the extension

period that are solely payments of principal and interest on the principal

amount outstanding, which may include reasonable additional compensation

for the extension of the contract.

B4.1.12Despite paragraph B4.1.10, a financial asset that would otherwise meet the condition

in paragraphs 4.1.2(b) and 4.1.2A(b) but does not do so only as a result of a

contractual term that permits (or requires) the issuer to prepay a debt instrument or

permits (or requires) the holder to put a debt instrument back to the issuer before

maturity is eligible to be measured at amortised cost or fair value through other

comprehensive income (subject to meeting the condition in paragraph 4.1.2(a) or the

condition in paragraph 4.1.2A(a)) if:

(a) the entity acquires or originates the financial asset at a premium or discount

to the contractual par amount;

(b) the prepayment amount substantially represents the contractual par amount

and accrued (but unpaid) contractual interest, which may include reasonable

compensation for the early termination of the contract; and

(c) when the entity initially recognises the financial asset, the fair value of the

prepayment feature is insignificant.

B4.1.12A For the purpose of applying paragraphs B4.1.11(b) and B4.1.12(b),

irrespective of the event or circumstance that causes the early termination of the

contract, a party may pay or receive reasonable compensation for that early

termination. For example, a party may pay or receive reasonable compensation when

it chooses to terminate the contract early (or otherwise causes the early termination to

occur).

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B4.1.13The following examples illustrate contractual cash flows that are solely payments of

principal and interest on the principal amount outstanding. This list of examples is

not exhaustive.

Instrument Analysis

Instrument A

Instrument A is a bond with a stated

maturity date. Payments of

principal and interest on the

principal amount outstanding are

linked to an inflation index of the

currency in which the instrument is

issued. The inflation link is not

leveraged and the principal is

protected.

The contractual cash flows are solely

payments of principal and interest on the

principal amount outstanding. Linking


principal amount outstanding to an

unleveraged inflation index resets the time

value of money to a current level. In other

words, the interest rate on the instrument

reflects ‘real’ interest. Thus, the interest

amounts are consideration for the time

value of money on the principal amount

outstanding.

However, if the interest payments were

indexed to another variable such as the

debtor’s performance (eg the debtor’s net

income) or an equity index, the contractual

cash flows are not payments of principal

and interest on the principal amount

outstanding (unless the indexing to the

debtor’s performance results in an

adjustment that only compensates the

holder for changes in the credit risk of the

instrument, such that contractual cash flows

are solely payments of principal and

interest). That is because the contractual

cash flows reflect a return that is

inconsistent with a basic lending

arrangement (see paragraph B4.1.7A).

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Instrument Analysis

Instrument B

Instrument B is a variable interest

rate instrument with a stated

maturity date that permits the

borrower to choose the market

interest rate on an ongoing basis.

For example, at each interest rate

reset date, the borrower can choose

to pay three-month LIBOR for a

three-month term or one-month

LIBOR for a one-month term.

The contractual cash flows are solely


principal amount outstanding as long as the

interest paid over the life of the instrument

reflects consideration for the time value of

money, for the credit risk associated with

the instrument and for other basic lending

risks and costs, as well as a profit margin

(see paragraph B4.1.7A). The fact that the

LIBOR interest rate is reset during the life

of the instrument does not in itself

disqualify the instrument.

However, if the borrower is able to choose

to pay a one-month interest rate that is reset

every three months, the interest rate is reset

with a frequency that does not match the

tenor of the interest rate. Consequently, the

time value of money element is modified.

Similarly, if an instrument has a contractual

interest rate that is based on a term that can

exceed the instrument’s remaining life (for

example, if an instrument with a five-year

maturity pays a variable rate that is reset

periodically but always reflects a five-year

maturity), the time value of money element

is modified. That is because the interest

payable in each period is disconnected from

the interest period.

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Instrument Analysis

In such cases, the entity must qualitatively

or quantitatively assess the contractual cash

flows against those on an instrument that is

identical in all respects except the tenor of

the interest rate matches the interest period

to determine if the cash flows are solely


principal amount outstanding. (But see

paragraph B4.1.9E for guidance on

regulated interest rates.)

For example, in assessing a bond with a

five-year term that pays a variable rate that

is reset every six months but always reflects

a five-year maturity, an entity considers the

contractual cash flows on an instrument that

resets every six months to a six-month

interest rate but is otherwise identical.

The same analysis would apply if the

borrower is able to choose between the

lender’s various published interest rates (eg

the borrower can choose between the

lender’s published one-month variable

interest rate and the lender’s published

three-month variable interest rate).

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Instrument Analysis

Instrument C

Instrument C is a bond with a stated

maturity date and pays a variable

market interest rate. That variable

interest rate is capped.

The contractual cash flows of both:

(a) an instrument that has a fixed

interest rate and

(b) an instrument that has a variable

interest rate

are payments of principal and interest on

the principal amount outstanding as long as

the interest reflects consideration for the

time value of money, for the credit risk

associated with the instrument during the

term of the instrument and for other basic

lending risks and costs, as well as a profit

margin. (See paragraph B4.1.7A)

Consequently, an instrument that is a

combination of (a) and (b) (eg a bond with

an interest rate cap) can have cash flows

that are solely payments of principal and

interest on the principal amount

outstanding. Such a contractual term may

reduce cash flow variability by setting a

limit on a variable interest rate (eg an

interest rate cap or floor) or increase the

cash flow variability because a fixed rate

becomes variable.

Instrument D

Instrument D is a full recourse loan

and is secured by collateral.

The fact that a full recourse loan is

collateralised does not in itself affect the

analysis of whether the contractual cash

flows are solely payments of principal and

interest on the principal amount

outstanding.

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Instrument Analysis

Instrument E

Instrument E is issued by a

regulated bank and has a stated

maturity date. The instrument pays

a fixed interest rate and all

contractual cash flows are non-

discretionary.

However, the issuer is subject to

legislation that permits or requires a

national resolving authority to

impose losses on holders of

particular instruments, including

Instrument E, in particular

circumstances. For example, the

national resolving authority has the

power to write down the par

amount of Instrument E or to

convert it into a fixed number of the

issuer’s ordinary shares if the

national resolving authority

determines that the issuer is having

severe financial difficulties, needs

additional regulatory capital or is

‘failing’.

The holder would analyse the contractual

terms of the financial instrument to

determine whether they give rise to cash

flows that are solely payments of principal


outstanding and thus are consistent with a

basic lending arrangement.

That analysis would not consider the

payments that arise only as a result of the

national resolving authority’s power to

impose losses on the holders of Instrument

E. That is because that power, and the

resulting payments, are not contractual

terms of the financial instrument.

In contrast, the contractual cash flows

would not be solely payments of principal


outstanding if the contractual terms of the

financial instrument permit or require the

issuer or another entity to impose losses on

the holder (eg by writing down the par

amount or by converting the instrument into

a fixed number of the issuer’s ordinary

shares) as long as those contractual terms

are genuine, even if the probability is

remote that such a loss will be imposed.

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B4.1.14The following examples illustrate contractual cash flows that are not solely payments

of principal and interest on the principal amount outstanding. This list of examples is

not exhaustive.

Instrument Analysis

Instrument F

Instrument F is a bond that is

convertible into a fixed number of

equity instruments of the issuer.

The holder would analyse the convertible

bond in its entirety.

The contractual cash flows are not payments

of principal and interest on the principal

amount outstanding because they reflect a

return that is inconsistent with a basic

lending arrangement (see paragraph

B4.1.7A); ie the return is linked to the value

of the equity of the issuer.

Instrument G

Instrument G is a loan that pays an

inverse floating interest rate (ie the

interest rate has an inverse

relationship to market interest

rates).

The contractual cash flows are not solely



The interest amounts are not consideration

for the time value of money on the principal

amount outstanding.

Instrument H

Instrument H is a perpetual

instrument but the issuer may call

the instrument at any point and pay

the holder the par amount plus

accrued interest due.

Instrument H pays a market interest

rate but payment of interest cannot

be made unless the issuer is able to

remain solvent immediately

afterwards.

Deferred interest does not accrue

additional interest.

The contractual cash flows are not payments

of principal and interest on the principal

amount outstanding. That is because the

issuer may be required to defer interest

payments and additional interest does not

accrue on those deferred interest amounts.

As a result, interest amounts are not

consideration for the time value of money on

the principal amount outstanding.

If interest accrued on the deferred amounts,

the contractual cash flows could be



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Instrument Analysis

The fact that Instrument H is perpetual does

not in itself mean that the contractual cash

flows are not payments of principal and

interest on the principal amount outstanding.

In effect, a perpetual instrument has

continuous (multiple) extension options.

Such options may result in contractual cash

flows that are payments of principal and

interest on the principal amount outstanding

if interest payments are mandatory and must

be paid in perpetuity.

Also, the fact that Instrument H is callable

does not mean that the contractual cash

flows are not payments of principal and

interest on the principal amount outstanding

unless it is callable at an amount that does

not substantially reflect payment of

outstanding principal and interest on that

principal amount outstanding. Even if the

callable amount includes an amount that

reasonably compensates the holder for the

early termination of the instrument, the

contractual cash flows could be payments of

principal and interest on the principal

amount outstanding. (See also paragraph

B4.1.12.)

B4.1.15In some cases a financial asset may have contractual cash flows that are described as

principal and interest but those cash flows do not represent the payment of principal

and interest on the principal amount outstanding as described in paragraphs 4.1.2(b),

4.1.2A(b) and 4.1.3 of this Standard.

B4.1.16This may be the case if the financial asset represents an investment in particular

assets or cash flows and hence the contractual cash flows are not solely payments of

principal and interest on the principal amount outstanding. For example, if the

contractual terms stipulate that the financial asset’s cash flows increase as more

automobiles use a particular toll road, those contractual cash flows are inconsistent

with a basic lending arrangement. As a result, the instrument would not satisfy the

condition in paragraphs 4.1.2(b) and 4.1.2A(b). This could be the case when a

creditor’s claim is limited to specified assets of the debtor or the cash flows from

specified assets (for example, a ‘non-recourse’ financial asset).

B4.1.17However, the fact that a financial asset is non-recourse does not in itself necessarily

preclude the financial asset from meeting the condition in paragraphs 4.1.2(b) and

4.1.2A(b). In such situations, the creditor is required to assess (‘look through to’) the

particular underlying assets or cash flows to determine whether the contractual cash

flows of the financial asset being classified are payments of principal and interest on

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the principal amount outstanding. If the terms of the financial asset give rise to any

other cash flows or limit the cash flows in a manner inconsistent with payments

representing principal and interest, the financial asset does not meet the condition in

paragraphs 4.1.2(b) and 4.1.2A(b). Whether the underlying assets are financial assets

or non-financial assets does not in itself affect this assessment.

B4.1.18A contractual cash flow characteristic does not affect the classification of the

financial asset if it could have only a de minimis effect on the contractual cash flows

of the financial asset. To make this determination, an entity must consider the

possible effect of the contractual cash flow characteristic in each reporting period and

cumulatively over the life of the financial instrument. In addition, if a contractual

cash flow characteristic could have an effect on the contractual cash flows that is

more than de minimis (either in a single reporting period or cumulatively) but that

cash flow characteristic is not genuine, it does not affect the classification of a

financial asset. A cash flow characteristic is not genuine if it affects the instrument’s

contractual cash flows only on the occurrence of an event that is extremely rare,

highly abnormal and very unlikely to occur.

B4.1.19In almost every lending transaction the creditor’s instrument is ranked relative to the

instruments of the debtor’s other creditors. An instrument that is subordinated to

other instruments may have contractual cash flows that are payments of principal and

interest on the principal amount outstanding if the debtor’s non-payment is a breach

of contract and the holder has a contractual right to unpaid amounts of principal and

interest on the principal amount outstanding even in the event of the debtor’s

bankruptcy. For example, a trade receivable that ranks its creditor as a general

creditor would qualify as having payments of principal and interest on the principal

amount outstanding. This is the case even if the debtor issued loans that are

collateralised, which in the event of bankruptcy would give that loan holder priority

over the claims of the general creditor in respect of the collateral but does not affect

the contractual right of the general creditor to unpaid principal and other amounts

due.

Contractually linked instruments

B4.1.20In some types of transactions, an issuer may prioritise payments to the holders of

financial assets using multiple contractually linked instruments that create

concentrations of credit risk (tranches). Each tranche has a subordination ranking that

specifies the order in which any cash flows generated by the issuer are allocated to

the tranche. In such situations, the holders of a tranche have the right to payments of

principal and interest on the principal amount outstanding only if the issuer generates

sufficient cash flows to satisfy higher-ranking tranches.

B4.1.21In such transactions, a tranche has cash flow characteristics that are payments of

principal and interest on the principal amount outstanding only if:

(a) the contractual terms of the tranche being assessed for classification (without

looking through to the underlying pool of financial instruments) give rise to

cash flows that are solely payments of principal and interest on the principal

amount outstanding (eg the interest rate on the tranche is not linked to a

commodity index);

(b) the underlying pool of financial instruments has the cash flow characteristics

set out in paragraphs B4.1.23 and B4.1.24; and

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(c) the exposure to credit risk in the underlying pool of financial instruments

inherent in the tranche is equal to or lower than the exposure to credit risk of

the underlying pool of financial instruments (for example, the credit rating of

the tranche being assessed for classification is equal to or higher than the

credit rating that would apply to a single tranche that funded the underlying

pool of financial instruments).

B4.1.22An entity must look through until it can identify the underlying pool of instruments

that are creating (instead of passing through) the cash flows. This is the underlying

pool of financial instruments.

B4.1.23The underlying pool must contain one or more instruments that have contractual cash

flows that are solely payments of principal and interest on the principal amount

outstanding.

B4.1.24The underlying pool of instruments may also include instruments that:

(a) reduce the cash flow variability of the instruments in paragraph B4.1.23 and,

when combined with the instruments in paragraph B4.1.23, result in cash

flows that are solely payments of principal and interest on the principal

amount outstanding (eg an interest rate cap or floor or a contract that reduces

the credit risk on some or all of the instruments in paragraph B4.1.23); or

(b) align the cash flows of the tranches with the cash flows of the pool of

underlying instruments in paragraph B4.1.23 to address differences in and

only in:

(i) whether the interest rate is fixed or floating;

(ii) the currency in which the cash flows are denominated, including

inflation in that currency; or

(iii) the timing of the cash flows.

B4.1.25If any instrument in the pool does not meet the conditions in either paragraph B4.1.23

or paragraph B4.1.24, the condition in paragraph B4.1.21(b) is not met. In

performing this assessment, a detailed instrument-by-instrument analysis of the pool

may not be necessary. However, an entity must use judgement and perform sufficient

analysis to determine whether the instruments in the pool meet the conditions in

paragraphs B4.1.23–B4.1.24. (See also paragraph B4.1.18 for guidance on

contractual cash flow characteristics that have only a de minimis effect.)

B4.1.26If the holder cannot assess the conditions in paragraph B4.1.21 at initial recognition,

the tranche must be measured at fair value through profit or loss. If the underlying

pool of instruments can change after initial recognition in such a way that the pool

may not meet the conditions in paragraphs B4.1.23–B4.1.24, the tranche does not

meet the conditions in paragraph B4.1.21 and must be measured at fair value through

profit or loss. However, if the underlying pool includes instruments that are

collateralised by assets that do not meet the conditions in paragraphs B4.1.23–

B4.1.24, the ability to take possession of such assets shall be disregarded for the

purposes of applying this paragraph unless the entity acquired the tranche with the

intention of controlling the collateral.

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Option to designate a financial asset or financial liability as at fair value through profit or loss (Sections 4.1 and 4.2)

B4.1.27Subject to the conditions in paragraphs 4.1.5 and 4.2.2, this Standard allows an entity

to designate a financial asset, a financial liability, or a group of financial instruments

(financial assets, financial liabilities or both) as at fair value through profit or loss

provided that doing so results in more relevant information.

B4.1.28The decision of an entity to designate a financial asset or financial liability as at fair

value through profit or loss is similar to an accounting policy choice (although,

unlike an accounting policy choice, it is not required to be applied consistently to all

similar transactions). When an entity has such a choice, paragraph 14(b) of NAS 8

requires the chosen policy to result in the financial statements providing reliable and

more relevant information about the effects of transactions, other events and

conditions on the entity’s financial position, financial performance or cash flows. For

example, in the case of designation of a financial liability as at fair value through

profit or loss, paragraph 4.2.2 sets out the two circumstances when the requirement

for more relevant information will be met. Accordingly, to choose such designation in

accordance with paragraph 4.2.2, the entity needs to demonstrate that it falls within

one (or both) of these two circumstances.

Designation eliminates or significantly reduces an accounting mismatch

B4.1.29Measurement of a financial asset or financial liability and classification of recognised

changes in its value are determined by the item’s classification and whether the item

is part of a designated hedging relationship. Those requirements can create a

measurement or recognition inconsistency (sometimes referred to as an ‘accounting

mismatch’) when, for example, in the absence of designation as at fair value through

profit or loss, a financial asset would be classified as subsequently measured at fair

value through profit or loss and a liability the entity considers related would be

subsequently measured at amortised cost (with changes in fair value not recognised).

In such circumstances, an entity may conclude that its financial statements would

provide more relevant information if both the asset and the liability were measured as

at fair value through profit or loss.

B4.1.30The following examples show when this condition could be met. In all cases, an

entity may use this condition to designate financial assets or financial liabilities as at

fair value through profit or loss only if it meets the principle in paragraph 4.1.5 or

4.2.2(a):

(a) an entity has contracts within the scope of NFRS 17 (the measurement of

which incorporates current information) and financial assets that it considers

to be related and that would otherwise be measured at either fair value

through other comprehensive income or amortised cost.

(b) an entity has financial assets, financial liabilities or both that share a risk,

such as interest rate risk, and that gives rise to opposite changes in fair value

that tend to offset each other. However, only some of the instruments would

be measured at fair value through profit or loss (for example, those that are

derivatives, or are classified as held for trading). It may also be the case that

the requirements for hedge accounting are not met because, for example, the

requirements for hedge effectiveness in paragraph 6.4.1 are not met.

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(c) an entity has financial assets, financial liabilities or both that share a risk,

such as interest rate risk, that gives rise to opposite changes in fair value that

tend to offset each other and none of the financial assets or financial

liabilities qualifies for designation as a hedging instrument because they are

not measured at fair value through profit or loss. Furthermore, in the absence

of hedge accounting there is a significant inconsistency in the recognition of

gains and losses. For example, the entity has financed a specified group of

loans by issuing traded bonds whose changes in fair value tend to offset each

other. If, in addition, the entity regularly buys and sells the bonds but rarely,

if ever, buys and sells the loans, reporting both the loans and the bonds at fair

value through profit or loss eliminates the inconsistency in the timing of the

recognition of the gains and losses that would otherwise result from

measuring them both at amortised cost and recognising a gain or loss each

time a bond is repurchased.

B4.1.31In cases such as those described in the preceding paragraph, to designate, at initial

recognition, the financial assets and financial liabilities not otherwise so measured as

at fair value through profit or loss may eliminate or significantly reduce the

measurement or recognition inconsistency and produce more relevant information.

For practical purposes, the entity need not enter into all of the assets and liabilities

giving rise to the measurement or recognition inconsistency at exactly the same time.

A reasonable delay is permitted provided that each transaction is designated as at fair

value through profit or loss at its initial recognition and, at that time, any remaining

transactions are expected to occur.

B4.1.32It would not be acceptable to designate only some of the financial assets and financial

liabilities giving rise to the inconsistency as at fair value through profit or loss if to

do so would not eliminate or significantly reduce the inconsistency and would

therefore not result in more relevant information. However, it would be acceptable to

designate only some of a number of similar financial assets or similar financial

liabilities if doing so achieves a significant reduction (and possibly a greater

reduction than other allowable designations) in the inconsistency. For example,

assume an entity has a number of similar financial liabilities that sum to CU100 and a

number of similar financial assets that sum to CU50 but are measured on a different

basis. The entity may significantly reduce the measurement inconsistency by

designating at initial recognition all of the assets but only some of the liabilities (for

example, individual liabilities with a combined total of CU45) as at fair value

through profit or loss. However, because designation as at fair value through profit or

loss can be applied only to the whole of a financial instrument, the entity in this

example must designate one or more liabilities in their entirety. It could not designate

either a component of a liability (eg changes in value attributable to only one risk,

such as changes in a benchmark interest rate) or a proportion (ie percentage) of a

liability.

A group of financial liabilities or financial assets and financial liabilities is managed and its performance is evaluated on a fair value basis

B4.1.33An entity may manage and evaluate the performance of a group of financial liabilities

or financial assets and financial liabilities in such a way that measuring that group at

fair value through profit or loss results in more relevant information. The focus in this

instance is on the way the entity manages and evaluates performance, instead of on

the nature of its financial instruments.

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B4.1.34For example, an entity may use this condition to designate financial liabilities as at

fair value through profit or loss if it meets the principle in paragraph 4.2.2(b) and the

entity has financial assets and financial liabilities that share one or more risks and

those risks are managed and evaluated on a fair value basis in accordance with a

documented policy of asset and liability management. An example could be an entity

that has issued ‘structured products’ containing multiple embedded derivatives and

manages the resulting risks on a fair value basis using a mix of derivative and non-

derivative financial instruments.

B4.1.35As noted above, this condition relies on the way the entity manages and evaluates

performance of the group of financial instruments under consideration. Accordingly,

(subject to the requirement of designation at initial recognition) an entity that

designates financial liabilities as at fair value through profit or loss on the basis of

this condition shall so designate all eligible financial liabilities that are managed and

evaluated together.

B4.1.36Documentation of the entity’s strategy need not be extensive but should be sufficient

to demonstrate compliance with paragraph 4.2.2(b). Such documentation is not

required for each individual item, but may be on a portfolio basis. For example, if the

performance management system for a department—as approved by the entity’s key

management personnel—clearly demonstrates that its performance is evaluated on

this basis, no further documentation is required to demonstrate compliance with

paragraph 4.2.2(b).

Embedded derivatives (Section 4.3)

B4.3.1 When an entity becomes a party to a hybrid contract with a host that is not an asset

within the scope of this Standard, paragraph 4.3.3 requires the entity to identify any

embedded derivative, assess whether it is required to be separated from the host

contract and, for those that are required to be separated, measure the derivatives at

fair value at initial recognition and subsequently at fair value through profit or loss.

B4.3.2 If a host contract has no stated or predetermined maturity and represents a residual

interest in the net assets of an entity, then its economic characteristics and risks are

those of an equity instrument, and an embedded derivative would need to possess

equity characteristics related to the same entity to be regarded as closely related. If

the host contract is not an equity instrument and meets the definition of a financial

instrument, then its economic characteristics and risks are those of a debt instrument.

B4.3.3 An embedded non-option derivative (such as an embedded forward or swap) is

separated from its host contract on the basis of its stated or implied substantive terms,

so as to result in it having a fair value of zero at initial recognition. An embedded

option-based derivative (such as an embedded put, call, cap, floor or swaption) is

separated from its host contract on the basis of the stated terms of the option feature.

The initial carrying amount of the host instrument is the residual amount after

separating the embedded derivative.

B4.3.4 Generally, multiple embedded derivatives in a single hybrid contract are treated as a

single compound embedded derivative. However, embedded derivatives that are

classified as equity (see NAS 32 Financial Instruments: Presentation) are accounted

for separately from those classified as assets or liabilities. In addition, if a hybrid

contract has more than one embedded derivative and those derivatives relate to

different risk exposures and are readily separable and independent of each other, they

are accounted for separately from each other.

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B4.3.5 The economic characteristics and risks of an embedded derivative are not closely

related to the host contract (paragraph 4.3.3(a)) in the following examples. In these

examples, assuming the conditions in paragraph 4.3.3(b) and (c) are met, an entity

accounts for the embedded derivative separately from the host contract.

(a) A put option embedded in an instrument that enables the holder to require the

issuer to reacquire the instrument for an amount of cash or other assets that

varies on the basis of the change in an equity or commodity price or index is

not closely related to a host debt instrument.

(b) An option or automatic provision to extend the remaining term to maturity of

a debt instrument is not closely related to the host debt instrument unless

there is a concurrent adjustment to the approximate current market rate of

interest at the time of the extension. If an entity issues a debt instrument and

the holder of that debt instrument writes a call option on the debt instrument

to a third party, the issuer regards the call option as extending the term to

maturity of the debt instrument provided the issuer can be required to

participate in or facilitate the remarketing of the debt instrument as a result of

the call option being exercised.

(c) Equity-indexed interest or principal payments embedded in a host debt

instrument or insurance contract—by which the amount of interest or

principal is indexed to the value of equity instruments—are not closely

related to the host instrument because the risks inherent in the host and the

embedded derivative are dissimilar.

(d) Commodity-indexed interest or principal payments embedded in a host debt

instrument or insurance contract—by which the amount of interest or

principal is indexed to the price of a commodity (such as gold)—are not

closely related to the host instrument because the risks inherent in the host

and the embedded derivative are dissimilar.

(e) A call, put, or prepayment option embedded in a host debt contract or host

insurance contract is not closely related to the host contract unless:

(i) the option’s exercise price is approximately equal on each exercise

date to the amortised cost of the host debt instrument or the carrying

amount of the host insurance contract; or

(ii) the exercise price of a prepayment option reimburses the lender for

an amount up to the approximate present value of lost interest for the

remaining term of the host contract. Lost interest is the product of the

principal amount prepaid multiplied by the interest rate differential.

The interest rate differential is the excess of the effective interest rate

of the host contract over the effective interest rate the entity would

receive at the prepayment date if it reinvested the principal amount

prepaid in a similar contract for the remaining term of the host

contract.

The assessment of whether the call or put option is closely related to the host

debt contract is made before separating the equity element of a convertible

debt instrument in accordance with NAS 32.

(f) Credit derivatives that are embedded in a host debt instrument and allow one

party (the ‘beneficiary’) to transfer the credit risk of a particular reference

asset, which it may not own, to another party (the ‘guarantor’) are not closely

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related to the host debt instrument. Such credit derivatives allow the

guarantor to assume the credit risk associated with the reference asset

without directly owning it.

B4.3.6 An example of a hybrid contract is a financial instrument that gives the holder a right

to put the financial instrument back to the issuer in exchange for an amount of cash

or other financial assets that varies on the basis of the change in an equity or

commodity index that may increase or decrease (a ‘puttable instrument’). Unless the

issuer on initial recognition designates the puttable instrument as a financial liability

at fair value through profit or loss, it is required to separate an embedded derivative

(ie the indexed principal payment) under paragraph 4.3.3 because the host contract is

a debt instrument under paragraph B4.3.2 and the indexed principal payment is not

closely related to a host debt instrument under paragraph B4.3.5(a). Because the

principal payment can increase and decrease, the embedded derivative is a non-

option derivative whose value is indexed to the underlying variable.

B4.3.7 In the case of a puttable instrument that can be put back at any time for cash equal to

a proportionate share of the net asset value of an entity (such as units of an open-

ended mutual fund or some unit-linked investment products), the effect of separating

an embedded derivative and accounting for each component is to measure the hybrid

contract at the redemption amount that is payable at the end of the reporting period if

the holder exercised its right to put the instrument back to the issuer.

B4.3.8 The economic characteristics and risks of an embedded derivative are closely related

to the economic characteristics and risks of the host contract in the following

examples. In these examples, an entity does not account for the embedded derivative

separately from the host contract.

(a) An embedded derivative in which the underlying is an interest rate or interest

rate index that can change the amount of interest that would otherwise be

paid or received on an interest-bearing host debt contract or insurance

contract is closely related to the host contract unless the hybrid contract can

be settled in such a way that the holder would not recover substantially all of

its recognised investment or the embedded derivative could at least double

the holder’s initial rate of return on the host contract and could result in a rate

of return that is at least twice what the market return would be for a contract

with the same terms as the host contract.

(b) An embedded floor or cap on the interest rate on a debt contract or insurance

contract is closely related to the host contract, provided the cap is at or above

the market rate of interest and the floor is at or below the market rate of

interest when the contract is issued, and the cap or floor is not leveraged in

relation to the host contract. Similarly, provisions included in a contract to

purchase or sell an asset (eg a commodity) that establish a cap and a floor on

the price to be paid or received for the asset are closely related to the host

contract if both the cap and floor were out of the money at inception and are

not leveraged.

(c) An embedded foreign currency derivative that provides a stream of principal

or interest payments that are denominated in a foreign currency and is

embedded in a host debt instrument (for example, a dual currency bond) is

closely related to the host debt instrument. Such a derivative is not separated

from the host instrument because NAS 21 The Effects of Changes in Foreign

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Exchange Rates requires foreign currency gains and losses on monetary

items to be recognised in profit or loss.

(d) An embedded foreign currency derivative in a host contract that is an

insurance contract or not a financial instrument (such as a contract for the

purchase or sale of a non-financial item where the price is denominated in a

foreign currency) is closely related to the host contract provided it is not

leveraged, does not contain an option feature, and requires payments

denominated in one of the following currencies:

(i) the functional currency of any substantial party to that contract;

(ii) the currency in which the price of the related good or service that is

acquired or delivered is routinely denominated in commercial

transactions around the world (such as the US dollar for crude oil

transactions); or

(iii) a currency that is commonly used in contracts to purchase or sell

non-financial items in the economic environment in which the

transaction takes place (eg a relatively stable and liquid currency that

is commonly used in local business transactions or external trade).

(e) An embedded prepayment option in an interest-only or principal-only strip is

closely related to the host contract provided the host contract (i) initially

resulted from separating the right to receive contractual cash flows of a

financial instrument that, in and of itself, did not contain an embedded

derivative, and (ii) does not contain any terms not present in the original host

debt contract.

(f) An embedded derivative in a host lease contract is closely related to the host

contract if the embedded derivative is (i) an inflation-related index such as an

index of lease payments to a consumer price index (provided that the lease is

not leveraged and the index relates to inflation in the entity’s own economic

environment), (ii) variable lease payments based on related sales or (iii)

variable lease payments based on variable interest rates.

(g) A unit-linking feature embedded in a host financial instrument or host

insurance contract is closely related to the host instrument or host contract if

the unit-denominated payments are measured at current unit values that

reflect the fair values of the assets of the fund. A unit-linking feature is a

contractual term that requires payments denominated in units of an internal

or external investment fund.

(h) A derivative embedded in an insurance contract is closely related to the host

insurance contract if the embedded derivative and host insurance contract are

so interdependent that an entity cannot measure the embedded derivative

separately (ie without considering the host contract).

Instruments containing embedded derivatives

B4.3.9 As noted in paragraph B4.3.1, when an entity becomes a party to a hybrid contract

with a host that is not an asset within the scope of this Standard and with one or more

embedded derivatives, paragraph 4.3.3 requires the entity to identify any such

embedded derivative, assess whether it is required to be separated from the host

contract and, for those that are required to be separated, measure the derivatives at

fair value at initial recognition and subsequently. These requirements can be more

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complex, or result in less reliable measures, than measuring the entire instrument at

fair value through profit or loss. For that reason this Standard permits the entire

hybrid contract to be designated as at fair value through profit or loss.

B4.3.10Such designation may be used whether paragraph 4.3.3 requires the embedded

derivatives to be separated from the host contract or prohibits such separation.

However, paragraph 4.3.5 would not justify designating the hybrid contract as at fair

value through profit or loss in the cases set out in paragraph 4.3.5(a) and (b) because

doing so would not reduce complexity or increase reliability.

Reassessment of embedded derivatives

B4.3.11 In accordance with paragraph 4.3.3, an entity shall assess whether an embedded

derivative is required to be separated from the host contract and accounted for as a

derivative when the entity first becomes a party to the contract. Subsequent

reassessment is prohibited unless there is a change in the terms of the contract that

significantly modifies the cash flows that otherwise would be required under the

contract, in which case reassessment is required. An entity determines whether a

modification to cash flows is significant by considering the extent to which the

expected future cash flows associated with the embedded derivative, the host contract

or both have changed and whether the change is significant relative to the previously

expected cash flows on the contract.

B4.3.12Paragraph B4.3.11 does not apply to embedded derivatives in contracts acquired in:

(a) a business combination (as defined in NFRS 3 Business Combinations);

(b) a combination of entities or businesses under common control as described in

paragraphs B1–B4 of NFRS 3; or

(c) the formation of a joint venture as defined in NFRS 11 Joint Arrangements

or their possible reassessment at the date of acquisition.3

Reclassification of financial assets (Section 4.4)

Reclassification of financial assets

B4.4.1 Paragraph 4.4.1 requires an entity to reclassify financial assets if the entity changes

its business model for managing those financial assets. Such changes are expected to

be very infrequent. Such changes are determined by the entity’s senior management

as a result of external or internal changes and must be significant to the entity’s

operations and demonstrable to external parties. Accordingly, a change in an entity’s

business model will occur only when an entity either begins or ceases to perform an

activity that is significant to its operations; for example, when the entity has acquired,

disposed of or terminated a business line. Examples of a change in business model

include the following:

(a) An entity has a portfolio of commercial loans that it holds to sell in the short

term. The entity acquires a company that manages commercial loans and has

a business model that holds the loans in order to collect the contractual cash

flows. The portfolio of commercial loans is no longer for sale, and the

portfolio is now managed together with the acquired commercial loans and

all are held to collect the contractual cash flows.

3�NFRS 3 addresses the acquisition of contracts with embedded derivatives in a business combination.

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(b) A financial services firm decides to shut down its retail mortgage business.

That business no longer accepts new business and the financial services firm

is actively marketing its mortgage loan portfolio for sale.

B4.4.2 A change in the objective of the entity’s business model must be effected before the

reclassification date. For example, if a financial services firm decides on 15 February

to shut down its retail mortgage business and hence must reclassify all affected

financial assets on 1 April (ie the first day of the entity’s next reporting period), the

entity must not accept new retail mortgage business or otherwise engage in activities

consistent with its former business model after 15 February.

B4.4.3 The following are not changes in business model:

(a) a change in intention related to particular financial assets (even in

circumstances of significant changes in market conditions).

(b) the temporary disappearance of a particular market for financial assets.

(c) a transfer of financial assets between parts of the entity with different

business models.

Measurement (Chapter 5)

Initial measurement (Section 5.1)

B5.1.1 The fair value of a financial instrument at initial recognition is normally the

transaction price (ie the fair value of the consideration given or received, see also

paragraph B5.1.2A and NFRS 13). However, if part of the consideration given or

received is for something other than the financial instrument, an entity shall measure

the fair value of the financial instrument. For example, the fair value of a long-term

loan or receivable that carries no interest can be measured as the present value of all

future cash receipts discounted using the prevailing market rate(s) of interest for a

similar instrument (similar as to currency, term, type of interest rate and other factors)

with a similar credit rating. Any additional amount lent is an expense or a reduction

of income unless it qualifies for recognition as some other type of asset.

B5.1.2 If an entity originates a loan that bears an off-market interest rate (eg 5 per cent when

the market rate for similar loans is 8 per cent), and receives an upfront fee as

compensation, the entity recognises the loan at its fair value, ie net of the fee it

receives.

B5.1.2A The best evidence of the fair value of a financial instrument at initial

recognition is normally the transaction price (ie the fair value of the consideration

given or received, see also NFRS 13). If an entity determines that the fair value at

initial recognition differs from the transaction price as mentioned in paragraph

5.1.1A, the entity shall account for that instrument at that date as follows:

(a) at the measurement required by paragraph 5.1.1 if that fair value is evidenced

by a quoted price in an active market for an identical asset or liability (ie a

Level 1 input) or based on a valuation technique that uses only data from

observable markets. An entity shall recognise the difference between the fair

value at initial recognition and the transaction price as a gain or loss.

(b) in all other cases, at the measurement required by paragraph 5.1.1, adjusted

to defer the difference between the fair value at initial recognition and the

transaction price. After initial recognition, the entity shall recognise that

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deferred difference as a gain or loss only to the extent that it arises from a

change in a factor (including time) that market participants would take into

account when pricing the asset or liability.

Subsequent measurement (Sections 5.2 and 5.3)

B5.2.1 If a financial instrument that was previously recognised as a financial asset is

measured at fair value through profit or loss and its fair value decreases below zero, it

is a financial liability measured in accordance with paragraph 4.2.1. However, hybrid

contracts with hosts that are assets within the scope of this Standard are always

measured in accordance with paragraph 4.3.2.

B5.2.2 The following example illustrates the accounting for transaction costs on the initial

and subsequent measurement of a financial asset measured at fair value with changes

through other comprehensive income in accordance with either paragraph 5.7.5 or

4.1.2A. An entity acquires a financial asset for CU100 plus a purchase commission of

CU2. Initially, the entity recognises the asset at CU102. The reporting period ends

one day later, when the quoted market price of the asset is CU100. If the asset were

sold, a commission of CU3 would be paid. On that date, the entity measures the asset

at CU100 (without regard to the possible commission on sale) and recognises a loss

of CU2 in other comprehensive income. If the financial asset is measured at fair

value through other comprehensive income in accordance with paragraph 4.1.2A, the

transaction costs are amortised to profit or loss using the effective interest method.

B5.2.2A The subsequent measurement of a financial asset or financial liability and the

subsequent recognition of gains and losses described in paragraph B5.1.2A shall be

consistent with the requirements of this Standard.

Investments in equity instruments and contracts on those investments

B5.2.3 All investments in equity instruments and contracts on those instruments must be

measured at fair value. However, in limited circumstances, cost may be an

appropriate estimate of fair value. That may be the case if insufficient more recent

information is available to measure fair value, or if there is a wide range of possible

fair value measurements and cost represents the best estimate of fair value within that

range.

B5.2.4 Indicators that cost might not be representative of fair value include:

(a) a significant change in the performance of the investee compared with

budgets, plans or milestones.

(b) changes in expectation that the investee’s technical product milestones will

be achieved.

(c) a significant change in the market for the investee’s equity or its products or

potential products.

(d) a significant change in the global economy or the economic environment in

which the investee operates.

(e) a significant change in the performance of comparable entities, or in the

valuations implied by the overall market.

(f) internal matters of the investee such as fraud, commercial disputes, litigation,

changes in management or strategy.

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(g) evidence from external transactions in the investee’s equity, either by the

investee (such as a fresh issue of equity), or by transfers of equity

instruments between third parties.

B5.2.5 The list in paragraph B5.2.4 is not exhaustive. An entity shall use all information

about the performance and operations of the investee that becomes available after the

date of initial recognition. To the extent that any such relevant factors exist, they may

indicate that cost might not be representative of fair value. In such cases, the entity

must measure fair value.

B5.2.6 Cost is never the best estimate of fair value for investments in quoted equity

instruments (or contracts on quoted equity instruments).

Amortised cost measurement (Section 5.4)

Effective interest method

B5.4.1 In applying the effective interest method, an entity identifies fees that are an integral

part of the effective interest rate of a financial instrument. The description of fees for

financial services may not be indicative of the nature and substance of the services

provided. Fees that are an integral part of the effective interest rate of a financial

instrument are treated as an adjustment to the effective interest rate, unless the

financial instrument is measured at fair value, with the change in fair value being

recognised in profit or loss. In those cases, the fees are recognised as revenue or

expense when the instrument is initially recognised.

B5.4.2 Fees that are an integral part of the effective interest rate of a financial instrument

include:

(a) origination fees received by the entity relating to the creation or acquisition

of a financial asset. Such fees may include compensation for activities such

as evaluating the borrower’s financial condition, evaluating and recording

guarantees, collateral and other security arrangements, negotiating the terms

of the instrument, preparing and processing documents and closing the

transaction. These fees are an integral part of generating an involvement with

the resulting financial instrument.

(b) commitment fees received by the entity to originate a loan when the loan

commitment is not measured in accordance with paragraph 4.2.1(a) and it is

probable that the entity will enter into a specific lending arrangement. These

fees are regarded as compensation for an ongoing involvement with the

acquisition of a financial instrument. If the commitment expires without the

entity making the loan, the fee is recognised as revenue on expiry.

(c) origination fees paid on issuing financial liabilities measured at amortised

cost. These fees are an integral part of generating an involvement with a

financial liability. An entity distinguishes fees and costs that are an integral

part of the effective interest rate for the financial liability from origination

fees and transaction costs relating to the right to provide services, such as

investment management services.

B5.4.3 Fees that are not an integral part of the effective interest rate of a financial instrument

and are accounted for in accordance with NFRS 15 include:

(a) fees charged for servicing a loan;

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(b) commitment fees to originate a loan when the loan commitment is not

measured in accordance with paragraph 4.2.1(a) and it is unlikely that a

specific lending arrangement will be entered into; and

(c) loan syndication fees received by an entity that arranges a loan and retains no

part of the loan package for itself (or retains a part at the same effective

interest rate for comparable risk as other participants).

B5.4.4 When applying the effective interest method, an entity generally amortises any fees,

points paid or received, transaction costs and other premiums or discounts that are

included in the calculation of the effective interest rate over the expected life of the

financial instrument. However, a shorter period is used if this is the period to which

the fees, points paid or received, transaction costs, premiums or discounts relate. This

will be the case when the variable to which the fees, points paid or received,

transaction costs, premiums or discounts relate is repriced to market rates before the

expected maturity of the financial instrument. In such a case, the appropriate

amortisation period is the period to the next such repricing date. For example, if a

premium or discount on a floating-rate financial instrument reflects the interest that

has accrued on that financial instrument since the interest was last paid, or changes in

the market rates since the floating interest rate was reset to the market rates, it will be

amortised to the next date when the floating interest is reset to market rates. This is

because the premium or discount relates to the period to the next interest reset date

because, at that date, the variable to which the premium or discount relates (ie

interest rates) is reset to the market rates. If, however, the premium or discount

results from a change in the credit spread over the floating rate specified in the

financial instrument, or other variables that are not reset to the market rates, it is

amortised over the expected life of the financial instrument.

B5.4.5 For floating-rate financial assets and floating-rate financial liabilities, periodic re-

estimation of cash flows to reflect the movements in the market rates of interest alters

the effective interest rate. If a floating-rate financial asset or a floating-rate financial

liability is recognised initially at an amount equal to the principal receivable or

payable on maturity, re-estimating the future interest payments normally has no

significant effect on the carrying amount of the asset or the liability.

B5.4.6 If an entity revises its estimates of payments or receipts (excluding modifications in

accordance with paragraph 5.4.3 and changes in estimates of expected credit losses),

it shall adjust the gross carrying amount of the financial asset or amortised cost of a

financial liability (or group of financial instruments) to reflect actual and revised

estimated contractual cash flows. The entity recalculates the gross carrying amount of

the financial asset or amortised cost of the financial liability as the present value of

the estimated future contractual cash flows that are discounted at the financial

instrument’s original effective interest rate (or credit-adjusted effective interest rate

for purchased or originated credit-impaired financial assets) or, when applicable, the

revised effective interest rate calculated in accordance with paragraph 6.5.10. The

adjustment is recognised in profit or loss as income or expense.

B5.4.7 In some cases a financial asset is considered credit-impaired at initial recognition

because the credit risk is very high, and in the case of a purchase it is acquired at a

deep discount. An entity is required to include the initial expected credit losses in the

estimated cash flows when calculating the credit-adjusted effective interest rate for

financial assets that are considered to be purchased or originated credit-impaired at

initial recognition. However, this does not mean that a credit-adjusted effective

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interest rate should be applied solely because the financial asset has high credit risk at

initial recognition.

Transaction costs

B5.4.8 Transaction costs include fees and commission paid to agents (including employees

acting as selling agents), advisers, brokers and dealers, levies by regulatory agencies

and security exchanges, and transfer taxes and duties. Transaction costs do not

include debt premiums or discounts, financing costs or internal administrative or

holding costs.

Write-off

B5.4.9 Write-offs can relate to a financial asset in its entirety or to a portion of it. For

example, an entity plans to enforce the collateral on a financial asset and expects to

recover no more than 30 per cent of the financial asset from the collateral. If the

entity has no reasonable prospects of recovering any further cash flows from the

financial asset, it should write off the remaining 70 per cent of the financial asset.

Impairment (Section 5.5)

Collective and individual assessment basis

B5.5.1 In order to meet the objective of recognising lifetime expected credit losses for

significant increases in credit risk since initial recognition, it may be necessary to

perform the assessment of significant increases in credit risk on a collective basis by

considering information that is indicative of significant increases in credit risk on, for

example, a group or sub-group of financial instruments. This is to ensure that an

entity meets the objective of recognising lifetime expected credit losses when there

are significant increases in credit risk, even if evidence of such significant increases

in credit risk at the individual instrument level is not yet available.

B5.5.2 Lifetime expected credit losses are generally expected to be recognised before a

financial instrument becomes past due. Typically, credit risk increases significantly

before a financial instrument becomes past due or other lagging borrower-specific

factors (for example, a modification or restructuring) are observed. Consequently

when reasonable and supportable information that is more forward-looking than past

due information is available without undue cost or effort, it must be used to assess

changes in credit risk.

B5.5.3 However, depending on the nature of the financial instruments and the credit risk

information available for particular groups of financial instruments, an entity may not

be able to identify significant changes in credit risk for individual financial

instruments before the financial instrument becomes past due. This may be the case

for financial instruments such as retail loans for which there is little or no updated

credit risk information that is routinely obtained and monitored on an individual

instrument until a customer breaches the contractual terms. If changes in the credit

risk for individual financial instruments are not captured before they become past

due, a loss allowance based only on credit information at an individual financial

instrument level would not faithfully represent the changes in credit risk since initial

recognition.

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B5.5.4 In some circumstances an entity does not have reasonable and supportable

information that is available without undue cost or effort to measure lifetime

expected credit losses on an individual instrument basis. In that case, lifetime

expected credit losses shall be recognised on a collective basis that considers

comprehensive credit risk information. This comprehensive credit risk information

must incorporate not only past due information but also all relevant credit

information, including forward-looking macroeconomic information, in order to

approximate the result of recognising lifetime expected credit losses when there has

been a significant increase in credit risk since initial recognition on an individual

instrument level.

B5.5.5 For the purpose of determining significant increases in credit risk and recognising a

loss allowance on a collective basis, an entity can group financial instruments on the

basis of shared credit risk characteristics with the objective of facilitating an analysis

that is designed to enable significant increases in credit risk to be identified on a

timely basis. The entity should not obscure this information by grouping financial

instruments with different risk characteristics. Examples of shared credit risk

characteristics may include, but are not limited to, the:

(a) instrument type;

(b) credit risk ratings;

(c) collateral type;

(d) date of initial recognition;

(e) remaining term to maturity;

(f) industry;

(g) geographical location of the borrower; and

(h) the value of collateral relative to the financial asset if it has an impact on the

probability of a default occurring (for example, non-recourse loans in some

jurisdictions or loan-to-value ratios).

B5.5.6 Paragraph 5.5.4 requires that lifetime expected credit losses are recognised on all

financial instruments for which there has been significant increases in credit risk

since initial recognition. In order to meet this objective, if an entity is not able to

group financial instruments for which the credit risk is considered to have increased

significantly since initial recognition based on shared credit risk characteristics, the

entity should recognise lifetime expected credit losses on a portion of the financial

assets for which credit risk is deemed to have increased significantly. The

aggregation of financial instruments to assess whether there are changes in credit risk

on a collective basis may change over time as new information becomes available on

groups of, or individual, financial instruments.

Timing of recognising lifetime expected credit losses

B5.5.7 The assessment of whether lifetime expected credit losses should be recognised is

based on significant increases in the likelihood or risk of a default occurring since

initial recognition (irrespective of whether a financial instrument has been repriced to

reflect an increase in credit risk) instead of on evidence of a financial asset being

credit-impaired at the reporting date or an actual default occurring. Generally, there

will be a significant increase in credit risk before a financial asset becomes credit-

impaired or an actual default occurs.

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B5.5.8 For loan commitments, an entity considers changes in the risk of a default occurring

on the loan to which a loan commitment relates. For financial guarantee contracts, an

entity considers the changes in the risk that the specified debtor will default on the

contract.

B5.5.9 The significance of a change in the credit risk since initial recognition depends on the

risk of a default occurring as at initial recognition. Thus, a given change, in absolute

terms, in the risk of a default occurring will be more significant for a financial

instrument with a lower initial risk of a default occurring compared to a financial

instrument with a higher initial risk of a default occurring.

B5.5.10The risk of a default occurring on financial instruments that have comparable credit

risk is higher the longer the expected life of the instrument; for example, the risk of a

default occurring on an AAA-rated bond with an expected life of 10 years is higher

than that on an AAA-rated bond with an expected life of five years.

B5.5.11 Because of the relationship between the expected life and the risk of a default

occurring, the change in credit risk cannot be assessed simply by comparing the

change in the absolute risk of a default occurring over time. For example, if the risk

of a default occurring for a financial instrument with an expected life of 10 years at

initial recognition is identical to the risk of a default occurring on that financial

instrument when its expected life in a subsequent period is only five years, that may

indicate an increase in credit risk. This is because the risk of a default occurring over

the expected life usually decreases as time passes if the credit risk is unchanged and

the financial instrument is closer to maturity. However, for financial instruments that

only have significant payment obligations close to the maturity of the financial

instrument the risk of a default occurring may not necessarily decrease as time

passes. In such a case, an entity should also consider other qualitative factors that

would demonstrate whether credit risk has increased significantly since initial

recognition.

B5.5.12An entity may apply various approaches when assessing whether the credit risk on a

financial instrument has increased significantly since initial recognition or when

measuring expected credit losses. An entity may apply different approaches for

different financial instruments. An approach that does not include an explicit

probability of default as an input per se, such as a credit loss rate approach, can be

consistent with the requirements in this Standard, provided that an entity is able to

separate the changes in the risk of a default occurring from changes in other drivers

of expected credit losses, such as collateral, and considers the following when

making the assessment:

(a) the change in the risk of a default occurring since initial recognition;

(b) the expected life of the financial instrument; and

(c) reasonable and supportable information that is available without undue cost

or effort that may affect credit risk.

B5.5.13The methods used to determine whether credit risk has increased significantly on a

financial instrument since initial recognition should consider the characteristics of the

financial instrument (or group of financial instruments) and the default patterns in the

past for comparable financial instruments. Despite the requirement in paragraph

5.5.9, for financial instruments for which default patterns are not concentrated at a

specific point during the expected life of the financial instrument, changes in the risk

of a default occurring over the next 12 months may be a reasonable approximation of

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the changes in the lifetime risk of a default occurring. In such cases, an entity may

use changes in the risk of a default occurring over the next 12 months to determine

whether credit risk has increased significantly since initial recognition, unless

circumstances indicate that a lifetime assessment is necessary.

B5.5.14However, for some financial instruments, or in some circumstances, it may not be

appropriate to use changes in the risk of a default occurring over the next 12 months

to determine whether lifetime expected credit losses should be recognised. For

example, the change in the risk of a default occurring in the next 12 months may not

be a suitable basis for determining whether credit risk has increased on a financial

instrument with a maturity of more than 12 months when:

(a) the financial instrument only has significant payment obligations beyond the

next 12 months;

(b) changes in relevant macroeconomic or other credit-related factors occur that

are not adequately reflected in the risk of a default occurring in the next 12

months; or

(c) changes in credit-related factors only have an impact on the credit risk of the

financial instrument (or have a more pronounced effect) beyond 12 months.

Determining whether credit risk has increased significantly since initial recognition

B5.5.15When determining whether the recognition of lifetime expected credit losses is

required, an entity shall consider reasonable and supportable information that is

available without undue cost or effort and that may affect the credit risk on a

financial instrument in accordance with paragraph 5.5.17(c). An entity need not

undertake an exhaustive search for information when determining whether credit risk

has increased significantly since initial recognition.

B5.5.16Credit risk analysis is a multifactor and holistic analysis; whether a specific factor is

relevant, and its weight compared to other factors, will depend on the type of

product, characteristics of the financial instruments and the borrower as well as the

geographical region. An entity shall consider reasonable and supportable information

that is available without undue cost or effort and that is relevant for the particular

financial instrument being assessed. However, some factors or indicators may not be

identifiable on an individual financial instrument level. In such a case, the factors or

indicators should be assessed for appropriate portfolios, groups of portfolios or

portions of a portfolio of financial instruments to determine whether the requirement

in paragraph 5.5.3 for the recognition of lifetime expected credit losses has been met.

B5.5.17The following non-exhaustive list of information may be relevant in assessing

changes in credit risk:

(a) significant changes in internal price indicators of credit risk as a result of a

change in credit risk since inception, including, but not limited to, the credit

spread that would result if a particular financial instrument or similar

financial instrument with the same terms and the same counterparty were

newly originated or issued at the reporting date.

(b) other changes in the rates or terms of an existing financial instrument that

would be significantly different if the instrument was newly originated or

issued at the reporting date (such as more stringent covenants, increased

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amounts of collateral or guarantees, or higher income coverage) because of

changes in the credit risk of the financial instrument since initial recognition.

(c) significant changes in external market indicators of credit risk for a particular

financial instrument or similar financial instruments with the same expected

life. Changes in market indicators of credit risk include, but are not limited

to:

(i) the credit spread;

(ii) the credit default swap prices for the borrower;

(iii) the length of time or the extent to which the fair value of a financial

asset has been less than its amortised cost; and

(iv) other market information related to the borrower, such as changes in

the price of a borrower’s debt and equity instruments.

(d) an actual or expected significant change in the financial instrument’s external

credit rating.

(e) an actual or expected internal credit rating downgrade for the borrower or

decrease in behavioural scoring used to assess credit risk internally. Internal

credit ratings and internal behavioural scoring are more reliable when they

are mapped to external ratings or supported by default studies.

(f) existing or forecast adverse changes in business, financial or economic

conditions that are expected to cause a significant change in the borrower’s

ability to meet its debt obligations, such as an actual or expected increase in

interest rates or an actual or expected significant increase in unemployment

rates.

(g) an actual or expected significant change in the operating results of the

borrower. Examples include actual or expected declining revenues or

margins, increasing operating risks, working capital deficiencies, decreasing

asset quality, increased balance sheet leverage, liquidity, management

problems or changes in the scope of business or organisational structure

(such as the discontinuance of a segment of the business) that results in a

significant change in the borrower’s ability to meet its debt obligations.

(h) significant increases in credit risk on other financial instruments of the same

borrower.

(i) an actual or expected significant adverse change in the regulatory, economic,

or technological environment of the borrower that results in a significant

change in the borrower’s ability to meet its debt obligations, such as a decline

in the demand for the borrower’s sales product because of a shift in

technology.

(j) significant changes in the value of the collateral supporting the obligation or

in the quality of third-party guarantees or credit enhancements, which are

expected to reduce the borrower’s economic incentive to make scheduled

contractual payments or to otherwise have an effect on the probability of a

default occurring. For example, if the value of collateral declines because

house prices decline, borrowers in some jurisdictions have a greater incentive

to default on their mortgages.

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(k) a significant change in the quality of the guarantee provided by a shareholder

(or an individual’s parents) if the shareholder (or parents) have an incentive

and financial ability to prevent default by capital or cash infusion.

(l) significant changes, such as reductions in financial support from a parent

entity or other affiliate or an actual or expected significant change in the

quality of credit enhancement, that are expected to reduce the borrower’s

economic incentive to make scheduled contractual payments. Credit quality

enhancements or support include the consideration of the financial condition

of the guarantor and/or, for interests issued in securitisations, whether

subordinated interests are expected to be capable of absorbing expected

credit losses (for example, on the loans underlying the security).

(m) expected changes in the loan documentation including an expected breach of

contract that may lead to covenant waivers or amendments, interest payment

holidays, interest rate step-ups, requiring additional collateral or guarantees,

or other changes to the contractual framework of the instrument.

(n) significant changes in the expected performance and behaviour of the

borrower, including changes in the payment status of borrowers in the group

(for example, an increase in the expected number or extent of delayed

contractual payments or significant increases in the expected number of

credit card borrowers who are expected to approach or exceed their credit

limit or who are expected to be paying the minimum monthly amount).

(o) changes in the entity’s credit management approach in relation to the

financial instrument; ie based on emerging indicators of changes in the credit

risk of the financial instrument, the entity’s credit risk management practice

is expected to become more active or to be focused on managing the

instrument, including the instrument becoming more closely monitored or

controlled, or the entity specifically intervening with the borrower.

(p) past due information, including the rebuttable presumption as set out in

paragraph 5.5.11.

B5.5.18In some cases, the qualitative and non-statistical quantitative information available

may be sufficient to determine that a financial instrument has met the criterion for the

recognition of a loss allowance at an amount equal to lifetime expected credit losses.

That is, the information does not need to flow through a statistical model or credit

ratings process in order to determine whether there has been a significant increase in

the credit risk of the financial instrument. In other cases, an entity may need to

consider other information, including information from its statistical models or credit

ratings processes. Alternatively, the entity may base the assessment on both types of

information, ie qualitative factors that are not captured through the internal ratings

process and a specific internal rating category at the reporting date, taking into

consideration the credit risk characteristics at initial recognition, if both types of

information are relevant.

More than 30 days past due rebuttable presumption

B5.5.19The rebuttable presumption in paragraph 5.5.11 is not an absolute indicator that

lifetime expected credit losses should be recognised, but is presumed to be the latest

point at which lifetime expected credit losses should be recognised even when using

forward-looking information (including macroeconomic factors on a portfolio level).

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B5.5.20An entity can rebut this presumption. However, it can do so only when it has

reasonable and supportable information available that demonstrates that even if

contractual payments become more than 30 days past due, this does not represent a

significant increase in the credit risk of a financial instrument. For example when

non-payment was an administrative oversight, instead of resulting from financial

difficulty of the borrower, or the entity has access to historical evidence that

demonstrates that there is no correlation between significant increases in the risk of a

default occurring and financial assets on which payments are more than 30 days past

due, but that evidence does identify such a correlation when payments are more than

60 days past due.

B5.5.21An entity cannot align the timing of significant increases in credit risk and the

recognition of lifetime expected credit losses to when a financial asset is regarded as

credit-impaired or an entity’s internal definition of default.

Financial instruments that have low credit risk at the reporting date

B5.5.22The credit risk on a financial instrument is considered low for the purposes of

paragraph 5.5.10, if the financial instrument has a low risk of default, the borrower

has a strong capacity to meet its contractual cash flow obligations in the near term

and adverse changes in economic and business conditions in the longer term may, but

will not necessarily, reduce the ability of the borrower to fulfil its contractual cash

flow obligations. Financial instruments are not considered to have low credit risk

when they are regarded as having a low risk of loss simply because of the value of

collateral and the financial instrument without that collateral would not be considered

low credit risk. Financial instruments are also not considered to have low credit risk

simply because they have a lower risk of default than the entity’s other financial

instruments or relative to the credit risk of the jurisdiction within which an entity

operates.

B5.5.23To determine whether a financial instrument has low credit risk, an entity may use its

internal credit risk ratings or other methodologies that are consistent with a globally

understood definition of low credit risk and that consider the risks and the type of

financial instruments that are being assessed. An external rating of ‘investment grade’

is an example of a financial instrument that may be considered as having low credit

risk. However, financial instruments are not required to be externally rated to be

considered to have low credit risk. They should, however, be considered to have low

credit risk from a market participant perspective taking into account all of the terms

and conditions of the financial instrument.

B5.5.24Lifetime expected credit losses are not recognised on a financial instrument simply

because it was considered to have low credit risk in the previous reporting period and

is not considered to have low credit risk at the reporting date. In such a case, an entity

shall determine whether there has been a significant increase in credit risk since

initial recognition and thus whether lifetime expected credit losses are required to be

recognised in accordance with paragraph 5.5.3.

Modifications

B5.5.25In some circumstances, the renegotiation or modification of the contractual cash

flows of a financial asset can lead to the derecognition of the existing financial asset

in accordance with this Standard. When the modification of a financial asset results

in the derecognition of the existing financial asset and the subsequent recognition of

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the modified financial asset, the modified asset is considered a ‘new’ financial asset

for the purposes of this Standard.

B5.5.26Accordingly the date of the modification shall be treated as the date of initial

recognition of that financial asset when applying the impairment requirements to the

modified financial asset. This typically means measuring the loss allowance at an

amount equal to 12-month expected credit losses until the requirements for the

recognition of lifetime expected credit losses in paragraph 5.5.3 are met. However, in

some unusual circumstances following a modification that results in derecognition of

the original financial asset, there may be evidence that the modified financial asset is

credit-impaired at initial recognition, and thus, the financial asset should be

recognised as an originated credit-impaired financial asset. This might occur, for

example, in a situation in which there was a substantial modification of a distressed

asset that resulted in the derecognition of the original financial asset. In such a case, it

may be possible for the modification to result in a new financial asset which is credit-

impaired at initial recognition.

B5.5.27If the contractual cash flows on a financial asset have been renegotiated or otherwise

modified, but the financial asset is not derecognised, that financial asset is not

automatically considered to have lower credit risk. An entity shall assess whether

there has been a significant increase in credit risk since initial recognition on the

basis of all reasonable and supportable information that is available without undue

cost or effort. This includes historical and forward-looking information and an

assessment of the credit risk over the expected life of the financial asset, which

includes information about the circumstances that led to the modification. Evidence

that the criteria for the recognition of lifetime expected credit losses are no longer

met may include a history of up-to-date and timely payment performance against the

modified contractual terms. Typically a customer would need to demonstrate

consistently good payment behaviour over a period of time before the credit risk is

considered to have decreased. For example, a history of missed or incomplete

payments would not typically be erased by simply making one payment on time

following a modification of the contractual terms.

Measurement of expected credit losses

Expected credit losses

B5.5.28Expected credit losses are a probability-weighted estimate of credit losses (ie the

present value of all cash shortfalls) over the expected life of the financial instrument.

A cash shortfall is the difference between the cash flows that are due to an entity in

accordance with the contract and the cash flows that the entity expects to receive.

Because expected credit losses consider the amount and timing of payments, a credit

loss arises even if the entity expects to be paid in full but later than when

contractually due.

B5.5.29For financial assets, a credit loss is the present value of the difference between:

(a) the contractual cash flows that are due to an entity under the contract; and

(b) the cash flows that the entity expects to receive.

B5.5.30For undrawn loan commitments, a credit loss is the present value of the difference

between:

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(a) the contractual cash flows that are due to the entity if the holder of the loan

commitment draws down the loan; and

(b) the cash flows that the entity expects to receive if the loan is drawn down.

B5.5.31An entity’s estimate of expected credit losses on loan commitments shall be

consistent with its expectations of drawdowns on that loan commitment, ie it shall

consider the expected portion of the loan commitment that will be drawn down

within 12 months of the reporting date when estimating 12-month expected credit

losses, and the expected portion of the loan commitment that will be drawn down

over the expected life of the loan commitment when estimating lifetime expected

credit losses.

B5.5.32For a financial guarantee contract, the entity is required to make payments only in the

event of a default by the debtor in accordance with the terms of the instrument that is

guaranteed. Accordingly, cash shortfalls are the expected payments to reimburse the

holder for a credit loss that it incurs less any amounts that the entity expects to

receive from the holder, the debtor or any other party. If the asset is fully guaranteed,

the estimation of cash shortfalls for a financial guarantee contract would be

consistent with the estimations of cash shortfalls for the asset subject to the

guarantee.

B5.5.33For a financial asset that is credit-impaired at the reporting date, but that is not a

purchased or originated credit-impaired financial asset, an entity shall measure the

expected credit losses as the difference between the asset’s gross carrying amount

and the present value of estimated future cash flows discounted at the financial

asset’s original effective interest rate. Any adjustment is recognised in profit or loss

as an impairment gain or loss.

B5.5.34When measuring a loss allowance for a lease receivable, the cash flows used for

determining the expected credit losses should be consistent with the cash flows used

in measuring the lease receivable in accordance with NFRS 16 Leases.

B5.5.35An entity may use practical expedients when measuring expected credit losses if they

are consistent with the principles in paragraph 5.5.17. An example of a practical

expedient is the calculation of the expected credit losses on trade receivables using a

provision matrix. The entity would use its historical credit loss experience (adjusted

as appropriate in accordance with paragraphs B5.5.51–B5.5.52) for trade receivables

to estimate the 12-month expected credit losses or the lifetime expected credit losses

on the financial assets as relevant. A provision matrix might, for example, specify

fixed provision rates depending on the number of days that a trade receivable is past

due (for example, 1 per cent if not past due, 2 per cent if less than 30 days past due, 3

per cent if more than 30 days but less than 90 days past due, 20 per cent if 90–180

days past due etc). Depending on the diversity of its customer base, the entity would

use appropriate groupings if its historical credit loss experience shows significantly

different loss patterns for different customer segments. Examples of criteria that

might be used to group assets include geographical region, product type, customer

rating, collateral or trade credit insurance and type of customer (such as wholesale or

retail).

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Definition of default

B5.5.36Paragraph 5.5.9 requires that when determining whether the credit risk on a financial

instrument has increased significantly, an entity shall consider the change in the risk

of a default occurring since initial recognition.

B5.5.37When defining default for the purposes of determining the risk of a default occurring,

an entity shall apply a default definition that is consistent with the definition used for

internal credit risk management purposes for the relevant financial instrument and

consider qualitative indicators (for example, financial covenants) when appropriate.

However, there is a rebuttable presumption that default does not occur later than

when a financial asset is 90 days past due unless an entity has reasonable and

supportable information to demonstrate that a more lagging default criterion is more

appropriate. The definition of default used for these purposes shall be applied

consistently to all financial instruments unless information becomes available that

demonstrates that another default definition is more appropriate for a particular

financial instrument.

Period over which to estimate expected credit losses

B5.5.38In accordance with paragraph 5.5.19, the maximum period over which expected

credit losses shall be measured is the maximum contractual period over which the

entity is exposed to credit risk. For loan commitments and financial guarantee

contracts, this is the maximum contractual period over which an entity has a present

contractual obligation to extend credit.

B5.5.39However, in accordance with paragraph 5.5.20, some financial instruments include

both a loan and an undrawn commitment component and the entity’s contractual

ability to demand repayment and cancel the undrawn commitment does not limit the

entity’s exposure to credit losses to the contractual notice period. For example,

revolving credit facilities, such as credit cards and overdraft facilities, can be

contractually withdrawn by the lender with as little as one day’s notice. However, in

practice lenders continue to extend credit for a longer period and may only withdraw

the facility after the credit risk of the borrower increases, which could be too late to

prevent some or all of the expected credit losses. These financial instruments

generally have the following characteristics as a result of the nature of the financial

instrument, the way in which the financial instruments are managed, and the nature

of the available information about significant increases in credit risk:

(a) the financial instruments do not have a fixed term or repayment structure and

usually have a short contractual cancellation period (for example, one day);

(b) the contractual ability to cancel the contract is not enforced in the normal

day-to-day management of the financial instrument and the contract may

only be cancelled when the entity becomes aware of an increase in credit risk

at the facility level; and

(c) the financial instruments are managed on a collective basis.

B5.5.40When determining the period over which the entity is expected to be exposed to

credit risk, but for which expected credit losses would not be mitigated by the entity’s

normal credit risk management actions, an entity should consider factors such as

historical information and experience about:

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(a) the period over which the entity was exposed to credit risk on similar

financial instruments;

(b) the length of time for related defaults to occur on similar financial

instruments following a significant increase in credit risk; and

(c) the credit risk management actions that an entity expects to take once the

credit risk on the financial instrument has increased, such as the reduction or

removal of undrawn limits.

Probability-weighted outcome

B5.5.41The purpose of estimating expected credit losses is neither to estimate a worst-case

scenario nor to estimate the best-case scenario. Instead, an estimate of expected credit

losses shall always reflect the possibility that a credit loss occurs and the possibility

that no credit loss occurs even if the most likely outcome is no credit loss.

B5.5.42Paragraph 5.5.17(a) requires the estimate of expected credit losses to reflect an

unbNASed and probability-weighted amount that is determined by evaluating a range

of possible outcomes. In practice, this may not need to be a complex analysis. In

some cases, relatively simple modelling may be sufficient, without the need for a

large number of detailed simulations of scenarios. For example, the average credit

losses of a large group of financial instruments with shared risk characteristics may

be a reasonable estimate of the probability-weighted amount. In other situations, the

identification of scenarios that specify the amount and timing of the cash flows for

particular outcomes and the estimated probability of those outcomes will probably be

needed. In those situations, the expected credit losses shall reflect at least two

outcomes in accordance with paragraph 5.5.18.

B5.5.43For lifetime expected credit losses, an entity shall estimate the risk of a default

occurring on the financial instrument during its expected life. 12-month expected

credit losses are a portion of the lifetime expected credit losses and represent the

lifetime cash shortfalls that will result if a default occurs in the 12 months after the

reporting date (or a shorter period if the expected life of a financial instrument is less

than 12 months), weighted by the probability of that default occurring. Thus, 12-

month expected credit losses are neither the lifetime expected credit losses that an

entity will incur on financial instruments that it predicts will default in the next 12

months nor the cash shortfalls that are predicted over the next 12 months.

Time value of money

B5.5.44Expected credit losses shall be discounted to the reporting date, not to the expected

default or some other date, using the effective interest rate determined at initial

recognition or an approximation thereof. If a financial instrument has a variable

interest rate, expected credit losses shall be discounted using the current effective

interest rate determined in accordance with paragraph B5.4.5.

B5.5.45For purchased or originated credit-impaired financial assets, expected credit losses

shall be discounted using the credit-adjusted effective interest rate determined at

initial recognition.

B5.5.46Expected credit losses on lease receivables shall be discounted using the same

discount rate used in the measurement of the lease receivable in accordance with

NFRS 16.

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B5.5.47The expected credit losses on a loan commitment shall be discounted using the

effective interest rate, or an approximation thereof, that will be applied when

recognising the financial asset resulting from the loan commitment. This is because

for the purpose of applying the impairment requirements, a financial asset that is

recognised following a draw down on a loan commitment shall be treated as a

continuation of that commitment instead of as a new financial instrument. The

expected credit losses on the financial asset shall therefore be measured considering

the initial credit risk of the loan commitment from the date that the entity became a

party to the irrevocable commitment.

B5.5.48Expected credit losses on financial guarantee contracts or on loan commitments for

which the effective interest rate cannot be determined shall be discounted by

applying a discount rate that reflects the current market assessment of the time value

of money and the risks that are specific to the cash flows but only if, and to the extent

that, the risks are taken into account by adjusting the discount rate instead of

adjusting the cash shortfalls being discounted.

Reasonable and supportable information

B5.5.49For the purpose of this Standard, reasonable and supportable information is that

which is reasonably available at the reporting date without undue cost or effort,

including information about past events, current conditions and forecasts of future

economic conditions. Information that is available for financial reporting purposes is

considered to be available without undue cost or effort.

B5.5.50An entity is not required to incorporate forecasts of future conditions over the entire

expected life of a financial instrument. The degree of judgement that is required to

estimate expected credit losses depends on the availability of detailed information. As

the forecast horizon increases, the availability of detailed information decreases and

the degree of judgement required to estimate expected credit losses increases. The

estimate of expected credit losses does not require a detailed estimate for periods that

are far in the future—for such periods, an entity may extrapolate projections from

available, detailed information.

B5.5.51An entity need not undertake an exhaustive search for information but shall consider

all reasonable and supportable information that is available without undue cost or

effort and that is relevant to the estimate of expected credit losses, including the

effect of expected prepayments. The information used shall include factors that are

specific to the borrower, general economic conditions and an assessment of both the

current as well as the forecast direction of conditions at the reporting date. An entity

may use various sources of data, that may be both internal (entity-specific) and

external. Possible data sources include internal historical credit loss experience,

internal ratings, credit loss experience of other entities and external ratings, reports

and statistics. Entities that have no, or insufficient, sources of entity-specific data

may use peer group experience for the comparable financial instrument (or groups of

financial instruments).

B5.5.52Historical information is an important anchor or base from which to measure

expected credit losses. However, an entity shall adjust historical data, such as credit

loss experience, on the basis of current observable data to reflect the effects of the

current conditions and its forecasts of future conditions that did not affect the period

on which the historical data is based, and to remove the effects of the conditions in

the historical period that are not relevant to the future contractual cash flows. In some

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cases, the best reasonable and supportable information could be the unadjusted

historical information, depending on the nature of the historical information and

when it was calculated, compared to circumstances at the reporting date and the

characteristics of the financial instrument being considered. Estimates of changes in

expected credit losses should reflect, and be directionally consistent with, changes in

related observable data from period to period (such as changes in unemployment

rates, property prices, commodity prices, payment status or other factors that are

indicative of credit losses on the financial instrument or in the group of financial

instruments and in the magnitude of those changes). An entity shall regularly review

the methodology and assumptions used for estimating expected credit losses to

reduce any differences between estimates and actual credit loss experience.

B5.5.53When using historical credit loss experience in estimating expected credit losses, it is

important that information about historical credit loss rates is applied to groups that

are defined in a manner that is consistent with the groups for which the historical

credit loss rates were observed. Consequently, the method used shall enable each

group of financial assets to be associated with information about past credit loss

experience in groups of financial assets with similar risk characteristics and with

relevant observable data that reflects current conditions.

B5.5.54Expected credit losses reflect an entity’s own expectations of credit losses. However,

when considering all reasonable and supportable information that is available without

undue cost or effort in estimating expected credit losses, an entity should also

consider observable market information about the credit risk of the particular

financial instrument or similar financial instruments.

Collateral

B5.5.55For the purposes of measuring expected credit losses, the estimate of expected cash

shortfalls shall reflect the cash flows expected from collateral and other credit

enhancements that are part of the contractual terms and are not recognised separately

by the entity. The estimate of expected cash shortfalls on a collateralised financial

instrument reflects the amount and timing of cash flows that are expected from

foreclosure on the collateral less the costs of obtaining and selling the collateral,

irrespective of whether foreclosure is probable (ie the estimate of expected cash

flows considers the probability of a foreclosure and the cash flows that would result

from it). Consequently, any cash flows that are expected from the realisation of the

collateral beyond the contractual maturity of the contract should be included in this

analysis. Any collateral obtained as a result of foreclosure is not recognised as an

asset that is separate from the collateralised financial instrument unless it meets the

relevant recognition criteria for an asset in this or other Standards.

Reclassification of financial assets (Section 5.6)

B5.6.1 If an entity reclassifies financial assets in accordance with paragraph 4.4.1, paragraph

5.6.1 requires that the reclassification is applied prospectively from the

reclassification date. Both the amortised cost measurement category and the fair

value through other comprehensive income measurement category require that the

effective interest rate is determined at initial recognition. Both of those measurement

categories also require that the impairment requirements are applied in the same way.

Consequently, when an entity reclassifies a financial asset between the amortised cost

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measurement category and the fair value through other comprehensive income

measurement category:

(a) the recognition of interest revenue will not change and therefore the entity

continues to use the same effective interest rate.

(b) the measurement of expected credit losses will not change because both

measurement categories apply the same impairment approach. However if a

financial asset is reclassified out of the fair value through other

comprehensive income measurement category and into the amortised cost

measurement category, a loss allowance would be recognised as an

adjustment to the gross carrying amount of the financial asset from the

reclassification date. If a financial asset is reclassified out of the amortised

cost measurement category and into the fair value through other

comprehensive income measurement category, the loss allowance would be

derecognised (and thus would no longer be recognised as an adjustment to

the gross carrying amount) but instead would be recognised as an

accumulated impairment amount (of an equal amount) in other

comprehensive income and would be disclosed from the reclassification date.

B5.6.2 However, an entity is not required to separately recognise interest revenue or

impairment gains or losses for a financial asset measured at fair value through profit

or loss. Consequently, when an entity reclassifies a financial asset out of the fair

value through profit or loss measurement category, the effective interest rate is

determined on the basis of the fair value of the asset at the reclassification date. In

addition, for the purposes of applying Section 5.5 to the financial asset from the

reclassification date, the date of the reclassification is treated as the date of initial

recognition.

Gains and losses (Section 5.7)

B5.7.1 Paragraph 5.7.5 permits an entity to make an irrevocable election to present in other

comprehensive income changes in the fair value of an investment in an equity

instrument that is not held for trading. This election is made on an instrument-by-

instrument (ie share-by-share) basis. Amounts presented in other comprehensive

income shall not be subsequently transferred to profit or loss. However, the entity

may transfer the cumulative gain or loss within equity. Dividends on such

investments are recognised in profit or loss in accordance with paragraph 5.7.6 unless

the dividend clearly represents a recovery of part of the cost of the investment.

B5.7.1A Unless paragraph 4.1.5 applies, paragraph 4.1.2A requires that a financial asset

is measured at fair value through other comprehensive income if the contractual

terms of the financial asset give rise to cash flows that are solely payments of

principal and interest on the principal amount outstanding and the asset is held in a

business model whose objective is achieved by both collecting contractual cash flows

and selling financial assets. This measurement category recognises information in

profit or loss as if the financial asset is measured at amortised cost, while the

financial asset is measured in the statement of financial position at fair value. Gains

or losses, other than those that are recognised in profit or loss in accordance with

paragraphs 5.7.10–5.7.11, are recognised in other comprehensive income. When

these financial assets are derecognised, cumulative gains or losses previously

recognised in other comprehensive income are reclassified to profit or loss. This

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reflects the gain or loss that would have been recognised in profit or loss upon

derecognition if the financial asset had been measured at amortised cost.

B5.7.2 An entity applies NAS 21 to financial assets and financial liabilities that are

monetary items in accordance with NAS 21 and denominated in a foreign currency.

NAS 21 requires any foreign exchange gains and losses on monetary assets and

monetary liabilities to be recognised in profit or loss. An exception is a monetary

item that is designated as a hedging instrument in a cash flow hedge (see paragraph

6.5.11), a hedge of a net investment (see paragraph 6.5.13) or a fair value hedge of an

equity instrument for which an entity has elected to present changes in fair value in

other comprehensive income in accordance with paragraph 5.7.5 (see paragraph

6.5.8).

B5.7.2A For the purpose of recognising foreign exchange gains and losses under NAS

21, a financial asset measured at fair value through other comprehensive income in

accordance with paragraph 4.1.2A is treated as a monetary item. Accordingly, such a

financial asset is treated as an asset measured at amortised cost in the foreign

currency. Exchange differences on the amortised cost are recognised in profit or loss

and other changes in the carrying amount are recognised in accordance with

paragraph 5.7.10.

B5.7.3 Paragraph 5.7.5 permits an entity to make an irrevocable election to present in other

comprehensive income subsequent changes in the fair value of particular investments

in equity instruments. Such an investment is not a monetary item. Accordingly, the

gain or loss that is presented in other comprehensive income in accordance with

paragraph 5.7.5 includes any related foreign exchange component.

B5.7.4 If there is a hedging relationship between a non-derivative monetary asset and a non-

derivative monetary liability, changes in the foreign currency component of those

financial instruments are presented in profit or loss.

Liabilities designated as at fair value through profit or loss

B5.7.5 When an entity designates a financial liability as at fair value through profit or loss, it

must determine whether presenting in other comprehensive income the effects of

changes in the liability’s credit risk would create or enlarge an accounting mismatch

in profit or loss. An accounting mismatch would be created or enlarged if presenting

the effects of changes in the liability’s credit risk in other comprehensive income

would result in a greater mismatch in profit or loss than if those amounts were

presented in profit or loss.

B5.7.6 To make that determination, an entity must assess whether it expects that the effects

of changes in the liability’s credit risk will be offset in profit or loss by a change in

the fair value of another financial instrument measured at fair value through profit or

loss. Such an expectation must be based on an economic relationship between the

characteristics of the liability and the characteristics of the other financial instrument.

B5.7.7 That determination is made at initial recognition and is not reassessed. For practical

purposes the entity need not enter into all of the assets and liabilities giving rise to an

accounting mismatch at exactly the same time. A reasonable delay is permitted

provided that any remaining transactions are expected to occur. An entity must apply

consistently its methodology for determining whether presenting in other

comprehensive income the effects of changes in the liability’s credit risk would

create or enlarge an accounting mismatch in profit or loss. However, an entity may

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use different methodologies when there are different economic relationships between

the characteristics of the liabilities designated as at fair value through profit or loss

and the characteristics of the other financial instruments. NFRS 7 requires an entity

to provide qualitative disclosures in the notes to the financial statements about its

methodology for making that determination.

B5.7.8 If such a mismatch would be created or enlarged, the entity is required to present all

changes in fair value (including the effects of changes in the credit risk of the

liability) in profit or loss. If such a mismatch would not be created or enlarged, the

entity is required to present the effects of changes in the liability’s credit risk in other

comprehensive income.

B5.7.9 Amounts presented in other comprehensive income shall not be subsequently

transferred to profit or loss. However, the entity may transfer the cumulative gain or

loss within equity.

B5.7.10The following example describes a situation in which an accounting mismatch would

be created in profit or loss if the effects of changes in the credit risk of the liability

were presented in other comprehensive income. A mortgage bank provides loans to

customers and funds those loans by selling bonds with matching characteristics (eg

amount outstanding, repayment profile, term and currency) in the market. The

contractual terms of the loan permit the mortgage customer to prepay its loan (ie

satisfy its obligation to the bank) by buying the corresponding bond at fair value in

the market and delivering that bond to the mortgage bank. As a result of that

contractual prepayment right, if the credit quality of the bond worsens (and, thus, the

fair value of the mortgage bank’s liability decreases), the fair value of the mortgage

bank’s loan asset also decreases. The change in the fair value of the asset reflects the

mortgage customer’s contractual right to prepay the mortgage loan by buying the

underlying bond at fair value (which, in this example, has decreased) and delivering

the bond to the mortgage bank. Consequently, the effects of changes in the credit risk

of the liability (the bond) will be offset in profit or loss by a corresponding change in

the fair value of a financial asset (the loan). If the effects of changes in the liability’s

credit risk were presented in other comprehensive income there would be an

accounting mismatch in profit or loss. Consequently, the mortgage bank is required to

present all changes in fair value of the liability (including the effects of changes in

the liability’s credit risk) in profit or loss.

B5.7.11 In the example in paragraph B5.7.10, there is a contractual linkage between the

effects of changes in the credit risk of the liability and changes in the fair value of the

financial asset (ie as a result of the mortgage customer’s contractual right to prepay

the loan by buying the bond at fair value and delivering the bond to the mortgage

bank). However, an accounting mismatch may also occur in the absence of a

contractual linkage.

B5.7.12For the purposes of applying the requirements in paragraphs 5.7.7 and 5.7.8, an

accounting mismatch is not caused solely by the measurement method that an entity

uses to determine the effects of changes in a liability’s credit risk. An accounting

mismatch in profit or loss would arise only when the effects of changes in the

liability’s credit risk (as defined in NFRS 7) are expected to be offset by changes in

the fair value of another financial instrument. A mismatch that arises solely as a result

of the measurement method (ie because an entity does not isolate changes in a

liability’s credit risk from some other changes in its fair value) does not affect the

determination required by paragraphs 5.7.7 and 5.7.8. For example, an entity may not

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isolate changes in a liability’s credit risk from changes in liquidity risk. If the entity

presents the combined effect of both factors in other comprehensive income, a

mismatch may occur because changes in liquidity risk may be included in the fair

value measurement of the entity’s financial assets and the entire fair value change of

those assets is presented in profit or loss. However, such a mismatch is caused by

measurement imprecision, not the offsetting relationship described in paragraph

B5.7.6 and, therefore, does not affect the determination required by paragraphs 5.7.7

and 5.7.8.

The meaning of ‘credit risk’ (paragraphs 5.7.7 and 5.7.8)

B5.7.13NFRS 7 defines credit risk as ‘the risk that one party to a financial instrument will

cause a financial loss for the other party by failing to discharge an obligation’. The

requirement in paragraph 5.7.7(a) relates to the risk that the issuer will fail to perform

on that particular liability. It does not necessarily relate to the creditworthiness of the

issuer. For example, if an entity issues a collateralised liability and a non-

collateralised liability that are otherwise identical, the credit risk of those two

liabilities will be different, even though they are issued by the same entity. The credit

risk on the collateralised liability will be less than the credit risk of the non-

collateralised liability. The credit risk for a collateralised liability may be close to

zero.

B5.7.14For the purposes of applying the requirement in paragraph 5.7.7(a), credit risk is

different from asset-specific performance risk. Asset-specific performance risk is not

related to the risk that an entity will fail to discharge a particular obligation but

instead it is related to the risk that a single asset or a group of assets will perform

poorly (or not at all).

B5.7.15The following are examples of asset-specific performance risk:

(a) a liability with a unit-linking feature whereby the amount due to investors is

contractually determined on the basis of the performance of specified assets.

The effect of that unit-linking feature on the fair value of the liability is asset-

specific performance risk, not credit risk.

(b) a liability issued by a structured entity with the following characteristics. The

entity is legally isolated so the assets in the entity are ring-fenced solely for

the benefit of its investors, even in the event of bankruptcy. The entity enters

into no other transactions and the assets in the entity cannot be hypothecated.

Amounts are due to the entity’s investors only if the ring-fenced assets

generate cash flows. Thus, changes in the fair value of the liability primarily

reflect changes in the fair value of the assets. The effect of the performance

of the assets on the fair value of the liability is asset-specific performance

risk, not credit risk.

Determining the effects of changes in credit risk

B5.7.16For the purposes of applying the requirement in paragraph 5.7.7(a), an entity shall

determine the amount of change in the fair value of the financial liability that is

attributable to changes in the credit risk of that liability either:

(a) as the amount of change in its fair value that is not attributable to changes in

market conditions that give rise to market risk (see paragraphs B5.7.17 and

B5.7.18); or

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(b) using an alternative method the entity believes more faithfully represents the

amount of change in the liability’s fair value that is attributable to changes in

its credit risk.

B5.7.17Changes in market conditions that give rise to market risk include changes in a

benchmark interest rate, the price of another entity’s financial instrument, a

commodity price, a foreign exchange rate or an index of prices or rates.

B5.7.18If the only significant relevant changes in market conditions for a liability are

changes in an observed (benchmark) interest rate, the amount in paragraph

B5.7.16(a) can be estimated as follows:

(a) First, the entity computes the liability’s internal rate of return at the start of

the period using the fair value of the liability and the liability’s contractual

cash flows at the start of the period. It deducts from this rate of return the

observed (benchmark) interest rate at the start of the period, to arrive at an

instrument-specific component of the internal rate of return.

(b) Next, the entity calculates the present value of the cash flows associated with

the liability using the liability’s contractual cash flows at the end of the

period and a discount rate equal to the sum of (i) the observed (benchmark)

interest rate at the end of the period and (ii) the instrument-specific

component of the internal rate of return as determined in (a).

(c) The difference between the fair value of the liability at the end of the period

and the amount determined in (b) is the change in fair value that is not

attributable to changes in the observed (benchmark) interest rate. This is the

amount to be presented in other comprehensive income in accordance with

paragraph 5.7.7(a).

B5.7.19The example in paragraph B5.7.18 assumes that changes in fair value arising from

factors other than changes in the instrument’s credit risk or changes in observed

(benchmark) interest rates are not significant. This method would not be appropriate

if changes in fair value arising from other factors are significant. In those cases, an

entity is required to use an alternative method that more faithfully measures the

effects of changes in the liability’s credit risk (see paragraph B5.7.16(b)). For

example, if the instrument in the example contains an embedded derivative, the

change in fair value of the embedded derivative is excluded in determining the

amount to be presented in other comprehensive income in accordance with paragraph

5.7.7(a).

B5.7.20As with all fair value measurements, an entity’s measurement method for

determining the portion of the change in the liability’s fair value that is attributable to

changes in its credit risk must make maximum use of relevant observable inputs and

minimum use of unobservable inputs.

Hedge accounting (Chapter 6)

Hedging instruments (Section 6.2)

Qualifying instruments

B6.2.1 Derivatives that are embedded in hybrid contracts, but that are not separately

accounted for, cannot be designated as separate hedging instruments.

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B6.2.2 An entity’s own equity instruments are not financial assets or financial liabilities of

the entity and therefore cannot be designated as hedging instruments.

B6.2.3 For hedges of foreign currency risk, the foreign currency risk component of a non-

derivative financial instrument is determined in accordance with NAS 21.

Written options

B6.2.4 This Standard does not restrict the circumstances in which a derivative that is

measured at fair value through profit or loss may be designated as a hedging

instrument, except for some written options. A written option does not qualify as a

hedging instrument unless it is designated as an offset to a purchased option,

including one that is embedded in another financial instrument (for example, a

written call option used to hedge a callable liability).

Designation of hedging instruments

B6.2.5 For hedges other than hedges of foreign currency risk, when an entity designates a

non-derivative financial asset or a non-derivative financial liability measured at fair

value through profit or loss as a hedging instrument, it may only designate the non-

derivative financial instrument in its entirety or a proportion of it.

B6.2.6 A single hedging instrument may be designated as a hedging instrument of more than

one type of risk, provided that there is a specific designation of the hedging

instrument and of the different risk positions as hedged items. Those hedged items

can be in different hedging relationships.

Hedged items (Section 6.3)

Qualifying items

B6.3.1 A firm commitment to acquire a business in a business combination cannot be a

hedged item, except for foreign currency risk, because the other risks being hedged

cannot be specifically identified and measured. Those other risks are general business

risks.

B6.3.2 An equity method investment cannot be a hedged item in a fair value hedge. This is

because the equity method recognises in profit or loss the investor’s share of the

investee’s profit or loss, instead of changes in the investment’s fair value. For a

similar reason, an investment in a consolidated subsidiary cannot be a hedged item in

a fair value hedge. This is because consolidation recognises in profit or loss the

subsidiary’s profit or loss, instead of changes in the investment’s fair value. A hedge

of a net investment in a foreign operation is different because it is a hedge of the

foreign currency exposure, not a fair value hedge of the change in the value of the

investment.

B6.3.3 Paragraph 6.3.4 permits an entity to designate as hedged items aggregated exposures

that are a combination of an exposure and a derivative. When designating such a

hedged item, an entity assesses whether the aggregated exposure combines an

exposure with a derivative so that it creates a different aggregated exposure that is

managed as one exposure for a particular risk (or risks). In that case, the entity may

designate the hedged item on the basis of the aggregated exposure. For example:

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(a) an entity may hedge a given quantity of highly probable coffee purchases in

15 months’ time against price risk (based on US dollars) using a 15-month

futures contract for coffee. The highly probable coffee purchases and the

futures contract for coffee in combination can be viewed as a 15-month

fixed-amount US dollar foreign currency risk exposure for risk management

purposes (ie like any fixed-amount US dollar cash outflow in 15 months’

time).

(b) an entity may hedge the foreign currency risk for the entire term of a 10-year

fixed-rate debt denominated in a foreign currency. However, the entity

requires fixed-rate exposure in its functional currency only for a short to

medium term (say two years) and floating rate exposure in its functional

currency for the remaining term to maturity. At the end of each of the two-

year intervals (ie on a two-year rolling basis) the entity fixes the next two

years’ interest rate exposure (if the interest level is such that the entity wants

to fix interest rates). In such a situation an entity may enter into a 10-year

fixed-to-floating cross-currency interest rate swap that swaps the fixed-rate

foreign currency debt into a variable-rate functional currency exposure. This

is overlaid with a two-year interest rate swap that—on the basis of the

functional currency—swaps variable-rate debt into fixed-rate debt. In effect,

the fixed-rate foreign currency debt and the 10-year fixed-to-floating cross-

currency interest rate swap in combination are viewed as a 10-year variable-

rate debt functional currency exposure for risk management purposes.

B6.3.4 When designating the hedged item on the basis of the aggregated exposure, an entity

considers the combined effect of the items that constitute the aggregated exposure for

the purpose of assessing hedge effectiveness and measuring hedge ineffectiveness.

However, the items that constitute the aggregated exposure remain accounted for

separately. This means that, for example:

(a) derivatives that are part of an aggregated exposure are recognised as separate

assets or liabilities measured at fair value; and

(b) if a hedging relationship is designated between the items that constitute the

aggregated exposure, the way in which a derivative is included as part of an

aggregated exposure must be consistent with the designation of that

derivative as the hedging instrument at the level of the aggregated exposure.

For example, if an entity excludes the forward element of a derivative from

its designation as the hedging instrument for the hedging relationship

between the items that constitute the aggregated exposure, it must also

exclude the forward element when including that derivative as a hedged item

as part of the aggregated exposure. Otherwise, the aggregated exposure shall

include a derivative, either in its entirety or a proportion of it.

B6.3.5 Paragraph 6.3.6 states that in consolidated financial statements the foreign currency

risk of a highly probable forecast intragroup transaction may qualify as a hedged item

in a cash flow hedge, provided that the transaction is denominated in a currency other

than the functional currency of the entity entering into that transaction and that the

foreign currency risk will affect consolidated profit or loss. For this purpose an entity

can be a parent, subsidiary, associate, joint arrangement or branch. If the foreign

currency risk of a forecast intragroup transaction does not affect consolidated profit

or loss, the intragroup transaction cannot qualify as a hedged item. This is usually the

case for royalty payments, interest payments or management charges between

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members of the same group, unless there is a related external transaction. However,

when the foreign currency risk of a forecast intragroup transaction will affect

consolidated profit or loss, the intragroup transaction can qualify as a hedged item.

An example is forecast sales or purchases of inventories between members of the

same group if there is an onward sale of the inventory to a party external to the

group. Similarly, a forecast intragroup sale of plant and equipment from the group

entity that manufactured it to a group entity that will use the plant and equipment in

its operations may affect consolidated profit or loss. This could occur, for example,

because the plant and equipment will be depreciated by the purchasing entity and the

amount initially recognised for the plant and equipment may change if the forecast

intragroup transaction is denominated in a currency other than the functional

currency of the purchasing entity.

B6.3.6 If a hedge of a forecast intragroup transaction qualifies for hedge accounting, any

gain or loss is recognised in, and taken out of, other comprehensive income in

accordance with paragraph 6.5.11. The relevant period or periods during which the

foreign currency risk of the hedged transaction affects profit or loss is when it affects

consolidated profit or loss.

Designation of hedged items

B6.3.7 A component is a hedged item that is less than the entire item. Consequently, a

component reflects only some of the risks of the item of which it is a part or reflects

the risks only to some extent (for example, when designating a proportion of an

item).

Risk components

B6.3.8 To be eligible for designation as a hedged item, a risk component must be a

separately identifiable component of the financial or the non-financial item, and the

changes in the cash flows or the fair value of the item attributable to changes in that

risk component must be reliably measurable.

B6.3.9 When identifying what risk components qualify for designation as a hedged item, an

entity assesses such risk components within the context of the particular market

structure to which the risk or risks relate and in which the hedging activity takes

place. Such a determination requires an evaluation of the relevant facts and

circumstances, which differ by risk and market.

B6.3.10When designating risk components as hedged items, an entity considers whether the

risk components are explicitly specified in a contract (contractually specified risk

components) or whether they are implicit in the fair value or the cash flows of an

item of which they are a part (non-contractually specified risk components). Non-

contractually specified risk components can relate to items that are not a contract (for

example, forecast transactions) or contracts that do not explicitly specify the

component (for example, a firm commitment that includes only one single price

instead of a pricing formula that references different underlyings). For example:

(a) Entity A has a long-term supply contract for natural gas that is priced using a

contractually specified formula that references commodities and other factors

(for example, gas oil, fuel oil and other components such as transport

charges). Entity A hedges the gas oil component in that supply contract using

a gas oil forward contract. Because the gas oil component is specified by the

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terms and conditions of the supply contract it is a contractually specified risk

component. Hence, because of the pricing formula, Entity A concludes that

the gas oil price exposure is separately identifiable. At the same time, there is

a market for gas oil forward contracts. Hence, Entity A concludes that the gas

oil price exposure is reliably measurable. Consequently, the gas oil price

exposure in the supply contract is a risk component that is eligible for

designation as a hedged item.

(b) Entity B hedges its future coffee purchases based on its production forecast.

Hedging starts up to 15 months before delivery for part of the forecast

purchase volume. Entity B increases the hedged volume over time (as the

delivery date approaches). Entity B uses two different types of contracts to

manage its coffee price risk:

(i) exchange-traded coffee futures contracts; and

(ii) coffee supply contracts for Arabica coffee from Colombia delivered

to a specific manufacturing site. These contracts price a tonne of

coffee based on the exchange-traded coffee futures contract price

plus a fixed price differential plus a variable logistics services charge

using a pricing formula. The coffee supply contract is an executory

contract in accordance with which Entity B takes actual delivery of

coffee.

For deliveries that relate to the current harvest, entering into the coffee

supply contracts allows Entity B to fix the price differential between the

actual coffee quality purchased (Arabica coffee from Colombia) and the

benchmark quality that is the underlying of the exchange-traded futures

contract. However, for deliveries that relate to the next harvest, the coffee

supply contracts are not yet available, so the price differential cannot be

fixed. Entity B uses exchange-traded coffee futures contracts to hedge the

benchmark quality component of its coffee price risk for deliveries that relate

to the current harvest as well as the next harvest. Entity B determines that it

is exposed to three different risks: coffee price risk reflecting the benchmark

quality, coffee price risk reflecting the difference (spread) between the price

for the benchmark quality coffee and the particular Arabica coffee from

Colombia that it actually receives, and the variable logistics costs. For

deliveries related to the current harvest, after Entity B enters into a coffee

supply contract, the coffee price risk reflecting the benchmark quality is a

contractually specified risk component because the pricing formula includes

an indexation to the exchange-traded coffee futures contract price. Entity B

concludes that this risk component is separately identifiable and reliably

measurable. For deliveries related to the next harvest, Entity B has not yet

entered into any coffee supply contracts (ie those deliveries are forecast

transactions). Hence, the coffee price risk reflecting the benchmark quality is

a non-contractually specified risk component. Entity B’s analysis of the

market structure takes into account how eventual deliveries of the particular

coffee that it receives are priced. Hence, on the basis of this analysis of the

market structure, Entity B concludes that the forecast transactions also

involve the coffee price risk that reflects the benchmark quality as a risk

component that is separately identifiable and reliably measurable even

though it is not contractually specified. Consequently, Entity B may

designate hedging relationships on a risk components basis (for the coffee

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price risk that reflects the benchmark quality) for coffee supply contracts as

well as forecast transactions.

(c) Entity C hedges part of its future jet fuel purchases on the basis of its

consumption forecast up to 24 months before delivery and increases the

volume that it hedges over time. Entity C hedges this exposure using

different types of contracts depending on the time horizon of the hedge,

which affects the market liquidity of the derivatives. For the longer time

horizons (12–24 months) Entity C uses crude oil contracts because only these

have sufficient market liquidity. For time horizons of 6–12 months Entity C

uses gas oil derivatives because they are sufficiently liquid. For time horizons

up to six months Entity C uses jet fuel contracts. Entity C’s analysis of the

market structure for oil and oil products and its evaluation of the relevant

facts and circumstances is as follows:

Entity C operates in a geographical area in which Brent is the crude

oil benchmark. Crude oil is a raw material benchmark that

affects the price of various refined oil products as their most

basic input. Gas oil is a benchmark for refined oil products,

which is used as a pricing reference for oil distillates more

generally. This is also reflected in the types of derivative

financial instruments for the crude oil and refined oil

products markets of the environment in which Entity C

operates, such as:• the benchmark crude oil futures contract,

which is for Brent crude oil;

• the benchmark gas oil futures contract, which is used as the

pricing reference for distillates—for example, jet fuel spread

derivatives cover the price differential between jet fuel and

that benchmark gas oil; and

• the benchmark gas oil crack spread derivative (ie the

derivative for the price differential between crude oil and gas

oil—a refining margin), which is indexed to Brent crude oil.

(ii) the pricing of refined oil products does not depend on which

particular crude oil is processed by a particular refinery because

those refined oil products (such as gas oil or jet fuel) are standardised

products.

Hence, Entity C concludes that the price risk of its jet fuel purchases includes

a crude oil price risk component based on Brent crude oil and a gas oil price

risk component, even though crude oil and gas oil are not specified in any

contractual arrangement. Entity C concludes that these two risk components

are separately identifiable and reliably measurable even though they are not

contractually specified. Consequently, Entity C may designate hedging

relationships for forecast jet fuel purchases on a risk components basis (for

crude oil or gas oil). This analysis also means that if, for example, Entity C

used crude oil derivatives based on West Texas Intermediate (WTI) crude oil,

changes in the price differential between Brent crude oil and WTI crude oil

would cause hedge ineffectiveness.

(d) Entity D holds a fixed-rate debt instrument. This instrument is issued in an

environment with a market in which a large variety of similar debt

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instruments are compared by their spreads to a benchmark rate (for example,

LIBOR) and variable-rate instruments in that environment are typically

indexed to that benchmark rate. Interest rate swaps are frequently used to

manage interest rate risk on the basis of that benchmark rate, irrespective of

the spread of debt instruments to that benchmark rate. The price of fixed-rate

debt instruments varies directly in response to changes in the benchmark rate

as they happen. Entity D concludes that the benchmark rate is a component

that can be separately identified and reliably measured. Consequently, Entity

D may designate hedging relationships for the fixed-rate debt instrument on a

risk component basis for the benchmark interest rate risk.

B6.3.11 When designating a risk component as a hedged item, the hedge accounting

requirements apply to that risk component in the same way as they apply to other

hedged items that are not risk components. For example, the qualifying criteria apply,

including that the hedging relationship must meet the hedge effectiveness

requirements, and any hedge ineffectiveness must be measured and recognised.

B6.3.12An entity can also designate only changes in the cash flows or fair value of a hedged

item above or below a specified price or other variable (a ‘one-sided risk’). The

intrinsic value of a purchased option hedging instrument (assuming that it has the

same principal terms as the designated risk), but not its time value, reflects a one-

sided risk in a hedged item. For example, an entity can designate the variability of

future cash flow outcomes resulting from a price increase of a forecast commodity

purchase. In such a situation, the entity designates only cash flow losses that result

from an increase in the price above the specified level. The hedged risk does not

include the time value of a purchased option, because the time value is not a

component of the forecast transaction that affects profit or loss.

B6.3.13There is a rebuttable presumption that unless inflation risk is contractually specified,

it is not separately identifiable and reliably measurable and hence cannot be

designated as a risk component of a financial instrument. However, in limited cases,

it is possible to identify a risk component for inflation risk that is separately

identifiable and reliably measurable because of the particular circumstances of the

inflation environment and the relevant debt market.

B6.3.14For example, an entity issues debt in an environment in which inflation-linked bonds

have a volume and term structure that results in a sufficiently liquid market that

allows constructing a term structure of zero-coupon real interest rates. This means

that for the respective currency, inflation is a relevant factor that is separately

considered by the debt markets. In those circumstances the inflation risk component

could be determined by discounting the cash flows of the hedged debt instrument

using the term structure of zero-coupon real interest rates (ie in a manner similar to

how a risk-free (nominal) interest rate component can be determined). Conversely, in

many cases an inflation risk component is not separately identifiable and reliably

measurable. For example, an entity issues only nominal interest rate debt in an

environment with a market for inflation-linked bonds that is not sufficiently liquid to

allow a term structure of zero-coupon real interest rates to be constructed. In this case

the analysis of the market structure and of the facts and circumstances does not

support the entity concluding that inflation is a relevant factor that is separately

considered by the debt markets. Hence, the entity cannot overcome the rebuttable

presumption that inflation risk that is not contractually specified is not separately

identifiable and reliably measurable. Consequently, an inflation risk component

would not be eligible for designation as the hedged item. This applies irrespective of

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any inflation hedging instrument that the entity has actually entered into. In

particular, the entity cannot simply impute the terms and conditions of the actual

inflation hedging instrument by projecting its terms and conditions onto the nominal

interest rate debt.

B6.3.15A contractually specified inflation risk component of the cash flows of a recognised

inflation-linked bond (assuming that there is no requirement to account for an

embedded derivative separately) is separately identifiable and reliably measurable, as

long as other cash flows of the instrument are not affected by the inflation risk

component.

Components of a nominal amount

B6.3.16There are two types of components of nominal amounts that can be designated as the

hedged item in a hedging relationship: a component that is a proportion of an entire

item or a layer component. The type of component changes the accounting outcome.

An entity shall designate the component for accounting purposes consistently with its

risk management objective.

B6.3.17An example of a component that is a proportion is 50 per cent of the contractual cash

flows of a loan.

B6.3.18A layer component may be specified from a defined, but open, population, or from a

defined nominal amount. Examples include:

(a) part of a monetary transaction volume, for example, the next FC10 cash

flows from sales denominated in a foreign currency after the first FC20 in

March 201X;4

(b) a part of a physical volume, for example, the bottom layer, measuring 5

million cubic metres, of the natural gas stored in location XYZ;

(c) a part of a physical or other transaction volume, for example, the first 100

barrels of the oil purchases in June 201X or the first 100 MWh of electricity

sales in June 201X; or

(d) a layer from the nominal amount of the hedged item, for example, the last

CU80 million of a CU100 million firm commitment, the bottom layer of

CU20 million of a CU100 million fixed-rate bond or the top layer of CU30

million from a total amount of CU100 million of fixed-rate debt that can be

prepaid at fair value (the defined nominal amount is CU100 million).

B6.3.19If a layer component is designated in a fair value hedge, an entity shall specify it

from a defined nominal amount. To comply with the requirements for qualifying fair

value hedges, an entity shall remeasure the hedged item for fair value changes (ie

remeasure the item for fair value changes attributable to the hedged risk). The fair

value hedge adjustment must be recognised in profit or loss no later than when the

item is derecognised. Consequently, it is necessary to track the item to which the fair

value hedge adjustment relates. For a layer component in a fair value hedge, this

requires an entity to track the nominal amount from which it is defined. For example,

in paragraph B6.3.18(d), the total defined nominal amount of CU100 million must be

tracked in order to track the bottom layer of CU20 million or the top layer of CU30

million.

4�In this Standard monetary amounts are denominated in ‘currency units’ (CU) and ‘foreign currency units’ (FC).

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B6.3.20A layer component that includes a prepayment option is not eligible to be designated

as a hedged item in a fair value hedge if the prepayment option’s fair value is affected

by changes in the hedged risk, unless the designated layer includes the effect of the

related prepayment option when determining the change in the fair value of the

hedged item.

Relationship between components and the total cash flows of an item

B6.3.21If a component of the cash flows of a financial or a non-financial item is designated

as the hedged item, that component must be less than or equal to the total cash flows

of the entire item. However, all of the cash flows of the entire item may be designated

as the hedged item and hedged for only one particular risk (for example, only for

those changes that are attributable to changes in LIBOR or a benchmark commodity

price).

B6.3.22For example, in the case of a financial liability whose effective interest rate is below

LIBOR, an entity cannot designate:

(a) a component of the liability equal to interest at LIBOR (plus the principal

amount in case of a fair value hedge); and

(b) a negative residual component.

B6.3.23However, in the case of a fixed-rate financial liability whose effective interest rate is

(for example) 100 basis points below LIBOR, an entity can designate as the hedged

item the change in the value of that entire liability (ie principal plus interest at

LIBOR minus 100 basis points) that is attributable to changes in LIBOR. If a fixed-

rate financial instrument is hedged some time after its origination and interest rates

have changed in the meantime, the entity can designate a risk component equal to a

benchmark rate that is higher than the contractual rate paid on the item. The entity

can do so provided that the benchmark rate is less than the effective interest rate

calculated on the assumption that the entity had purchased the instrument on the day

when it first designates the hedged item. For example, assume that an entity

originates a fixed-rate financial asset of CU100 that has an effective interest rate of 6

per cent at a time when LIBOR is 4 per cent. It begins to hedge that asset some time

later when LIBOR has increased to 8 per cent and the fair value of the asset has

decreased to CU90. The entity calculates that if it had purchased the asset on the date

it first designates the related LIBOR interest rate risk as the hedged item, the

effective yield of the asset based on its then fair value of CU90 would have been 9.5

per cent. Because LIBOR is less than this effective yield, the entity can designate a

LIBOR component of 8 per cent that consists partly of the contractual interest cash

flows and partly of the difference between the current fair value (ie CU90) and the

amount repayable on maturity (ie CU100).

B6.3.24If a variable-rate financial liability bears interest of (for example) three-month

LIBOR minus 20 basis points (with a floor at zero basis points), an entity can

designate as the hedged item the change in the cash flows of that entire liability (ie

three-month LIBOR minus 20 basis points—including the floor) that is attributable to

changes in LIBOR. Hence, as long as the three-month LIBOR forward curve for the

remaining life of that liability does not fall below 20 basis points, the hedged item

has the same cash flow variability as a liability that bears interest at three-month

LIBOR with a zero or positive spread. However, if the three-month LIBOR forward

curve for the remaining life of that liability (or a part of it) falls below 20 basis

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points, the hedged item has a lower cash flow variability than a liability that bears

interest at three-month LIBOR with a zero or positive spread.

B6.3.25A similar example of a non-financial item is a specific type of crude oil from a

particular oil field that is priced off the relevant benchmark crude oil. If an entity

sells that crude oil under a contract using a contractual pricing formula that sets the

price per barrel at the benchmark crude oil price minus CU10 with a floor of CU15,

the entity can designate as the hedged item the entire cash flow variability under the

sales contract that is attributable to the change in the benchmark crude oil price.

However, the entity cannot designate a component that is equal to the full change in

the benchmark crude oil price. Hence, as long as the forward price (for each delivery)

does not fall below CU25, the hedged item has the same cash flow variability as a

crude oil sale at the benchmark crude oil price (or with a positive spread). However,

if the forward price for any delivery falls below CU25, the hedged item has a lower

cash flow variability than a crude oil sale at the benchmark crude oil price (or with a

positive spread).

Qualifying criteria for hedge accounting (Section 6.4)

Hedge effectiveness

B6.4.1 Hedge effectiveness is the extent to which changes in the fair value or the cash flows

of the hedging instrument offset changes in the fair value or the cash flows of the

hedged item (for example, when the hedged item is a risk component, the relevant

change in fair value or cash flows of an item is the one that is attributable to the

hedged risk). Hedge ineffectiveness is the extent to which the changes in the fair

value or the cash flows of the hedging instrument are greater or less than those on the

hedged item.

B6.4.2 When designating a hedging relationship and on an ongoing basis, an entity shall

analyse the sources of hedge ineffectiveness that are expected to affect the hedging

relationship during its term. This analysis (including any updates in accordance with

paragraph B6.5.21 arising from rebalancing a hedging relationship) is the basis for

the entity’s assessment of meeting the hedge effectiveness requirements.

B6.4.3 For the avoidance of doubt, the effects of replacing the original counterparty with a

clearing counterparty and making the associated changes as described in paragraph

6.5.6 shall be reflected in the measurement of the hedging instrument and therefore in

the assessment of hedge effectiveness and the measurement of hedge effectiveness.

Economic relationship between the hedged item and the hedging instrument

B6.4.4 The requirement that an economic relationship exists means that the hedging

instrument and the hedged item have values that generally move in the opposite

direction because of the same risk, which is the hedged risk. Hence, there must be an

expectation that the value of the hedging instrument and the value of the hedged item

will systematically change in response to movements in either the same underlying or

underlyings that are economically related in such a way that they respond in a similar

way to the risk that is being hedged (for example, Brent and WTI crude oil).

B6.4.5 If the underlyings are not the same but are economically related, there can be

situations in which the values of the hedging instrument and the hedged item move in

the same direction, for example, because the price differential between the two

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related underlyings changes while the underlyings themselves do not move

significantly. That is still consistent with an economic relationship between the

hedging instrument and the hedged item if the values of the hedging instrument and

the hedged item are still expected to typically move in the opposite direction when

the underlyings move.

B6.4.6 The assessment of whether an economic relationship exists includes an analysis of

the possible behaviour of the hedging relationship during its term to ascertain

whether it can be expected to meet the risk management objective. The mere

existence of a statistical correlation between two variables does not, by itself, support

a valid conclusion that an economic relationship exists.

The effect of credit risk

B6.4.7 Because the hedge accounting model is based on a general notion of offset between

gains and losses on the hedging instrument and the hedged item, hedge effectiveness

is determined not only by the economic relationship between those items (ie the

changes in their underlyings) but also by the effect of credit risk on the value of both

the hedging instrument and the hedged item. The effect of credit risk means that even

if there is an economic relationship between the hedging instrument and the hedged

item, the level of offset might become erratic. This can result from a change in the

credit risk of either the hedging instrument or the hedged item that is of such a

magnitude that the credit risk dominates the value changes that result from the

economic relationship (ie the effect of the changes in the underlyings). A level of

magnitude that gives rise to dominance is one that would result in the loss (or gain)

from credit risk frustrating the effect of changes in the underlyings on the value of the

hedging instrument or the hedged item, even if those changes were significant.

Conversely, if during a particular period there is little change in the underlyings, the

fact that even small credit risk-related changes in the value of the hedging instrument

or the hedged item might affect the value more than the underlyings does not create

dominance.

B6.4.8 An example of credit risk dominating a hedging relationship is when an entity hedges

an exposure to commodity price risk using an uncollateralised derivative. If the

counterparty to that derivative experiences a severe deterioration in its credit

standing, the effect of the changes in the counterparty’s credit standing might

outweigh the effect of changes in the commodity price on the fair value of the

hedging instrument, whereas changes in the value of the hedged item depend largely

on the commodity price changes.

Hedge ratio

B6.4.9 In accordance with the hedge effectiveness requirements, the hedge ratio of the

hedging relationship must be the same as that resulting from the quantity of the

hedged item that the entity actually hedges and the quantity of the hedging

instrument that the entity actually uses to hedge that quantity of hedged item. Hence,

if an entity hedges less than 100 per cent of the exposure on an item, such as 85 per

cent, it shall designate the hedging relationship using a hedge ratio that is the same as

that resulting from 85 per cent of the exposure and the quantity of the hedging

instrument that the entity actually uses to hedge those 85 per cent. Similarly, if, for

example, an entity hedges an exposure using a nominal amount of 40 units of a

financial instrument, it shall designate the hedging relationship using a hedge ratio

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that is the same as that resulting from that quantity of 40 units (ie the entity must not

use a hedge ratio based on a higher quantity of units that it might hold in total or a

lower quantity of units) and the quantity of the hedged item that it actually hedges

with those 40 units.

B6.4.10However, the designation of the hedging relationship using the same hedge ratio as

that resulting from the quantities of the hedged item and the hedging instrument that

the entity actually uses shall not reflect an imbalance between the weightings of the

hedged item and the hedging instrument that would in turn create hedge

ineffectiveness (irrespective of whether recognised or not) that could result in an

accounting outcome that would be inconsistent with the purpose of hedge accounting.

Hence, for the purpose of designating a hedging relationship, an entity must adjust

the hedge ratio that results from the quantities of the hedged item and the hedging

instrument that the entity actually uses if that is needed to avoid such an imbalance.

B6.4.11 Examples of relevant considerations in assessing whether an accounting outcome is

inconsistent with the purpose of hedge accounting are:

(a) whether the intended hedge ratio is established to avoid recognising hedge

ineffectiveness for cash flow hedges, or to achieve fair value hedge

adjustments for more hedged items with the aim of increasing the use of fair

value accounting, but without offsetting fair value changes of the hedging

instrument; and

(b) whether there is a commercial reason for the particular weightings of the

hedged item and the hedging instrument, even though that creates hedge

ineffectiveness. For example, an entity enters into and designates a quantity

of the hedging instrument that is not the quantity that it determined as the

best hedge of the hedged item because the standard volume of the hedging

instruments does not allow it to enter into that exact quantity of hedging

instrument (a ‘lot size issue’). An example is an entity that hedges 100 tonnes

of coffee purchases with standard coffee futures contracts that have a contract

size of 37,500 lbs (pounds). The entity could only use either five or six

contracts (equivalent to 85.0 and 102.1 tonnes respectively) to hedge the

purchase volume of 100 tonnes. In that case, the entity designates the

hedging relationship using the hedge ratio that results from the number of

coffee futures contracts that it actually uses, because the hedge

ineffectiveness resulting from the mismatch in the weightings of the hedged

item and the hedging instrument would not result in an accounting outcome

that is inconsistent with the purpose of hedge accounting.

Frequency of assessing whether the hedge effectiveness requirements are met

B6.4.12An entity shall assess at the inception of the hedging relationship, and on an ongoing

basis, whether a hedging relationship meets the hedge effectiveness requirements. At

a minimum, an entity shall perform the ongoing assessment at each reporting date or

upon a significant change in the circumstances affecting the hedge effectiveness

requirements, whichever comes first. The assessment relates to expectations about

hedge effectiveness and is therefore only forward-looking.

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Methods for assessing whether the hedge effectiveness requirements are met

B6.4.13This Standard does not specify a method for assessing whether a hedging relationship

meets the hedge effectiveness requirements. However, an entity shall use a method

that captures the relevant characteristics of the hedging relationship including the

sources of hedge ineffectiveness. Depending on those factors, the method can be a

qualitative or a quantitative assessment.

B6.4.14For example, when the critical terms (such as the nominal amount, maturity and

underlying) of the hedging instrument and the hedged item match or are closely

aligned, it might be possible for an entity to conclude on the basis of a qualitative

assessment of those critical terms that the hedging instrument and the hedged item

have values that will generally move in the opposite direction because of the same

risk and hence that an economic relationship exists between the hedged item and the

hedging instrument (see paragraphs B6.4.4–B6.4.6).

B6.4.15The fact that a derivative is in or out of the money when it is designated as a hedging

instrument does not in itself mean that a qualitative assessment is inappropriate. It

depends on the circumstances whether hedge ineffectiveness arising from that fact

could have a magnitude that a qualitative assessment would not adequately capture.

B6.4.16Conversely, if the critical terms of the hedging instrument and the hedged item are

not closely aligned, there is an increased level of uncertainty about the extent of

offset. Consequently, the hedge effectiveness during the term of the hedging

relationship is more difficult to predict. In such a situation it might only be possible

for an entity to conclude on the basis of a quantitative assessment that an economic

relationship exists between the hedged item and the hedging instrument (see

paragraphs B6.4.4–B6.4.6). In some situations a quantitative assessment might also

be needed to assess whether the hedge ratio used for designating the hedging

relationship meets the hedge effectiveness requirements (see paragraphs B6.4.9–

B6.4.11). An entity can use the same or different methods for those two different

purposes.

B6.4.17If there are changes in circumstances that affect hedge effectiveness, an entity may

have to change the method for assessing whether a hedging relationship meets the

hedge effectiveness requirements in order to ensure that the relevant characteristics of

the hedging relationship, including the sources of hedge ineffectiveness, are still

captured.

B6.4.18An entity’s risk management is the main source of information to perform the

assessment of whether a hedging relationship meets the hedge effectiveness

requirements. This means that the management information (or analysis) used for

decision-making purposes can be used as a basis for assessing whether a hedging

relationship meets the hedge effectiveness requirements.

B6.4.19An entity’s documentation of the hedging relationship includes how it will assess the

hedge effectiveness requirements, including the method or methods used. The

documentation of the hedging relationship shall be updated for any changes to the

methods (see paragraph B6.4.17).

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Accounting for qualifying hedging relationships (Section 6.5)

B6.5.1 An example of a fair value hedge is a hedge of exposure to changes in the fair value

of a fixed-rate debt instrument arising from changes in interest rates. Such a hedge

could be entered into by the issuer or by the holder.

B6.5.2 The purpose of a cash flow hedge is to defer the gain or loss on the hedging

instrument to a period or periods in which the hedged expected future cash flows

affect profit or loss. An example of a cash flow hedge is the use of a swap to change

floating rate debt (whether measured at amortised cost or fair value) to fixed-rate debt

(ie a hedge of a future transaction in which the future cash flows being hedged are the

future interest payments). Conversely, a forecast purchase of an equity instrument

that, once acquired, will be accounted for at fair value through profit or loss, is an

example of an item that cannot be the hedged item in a cash flow hedge, because any

gain or loss on the hedging instrument that would be deferred could not be

appropriately reclassified to profit or loss during a period in which it would achieve

offset. For the same reason, a forecast purchase of an equity instrument that, once

acquired, will be accounted for at fair value with changes in fair value presented in

other comprehensive income also cannot be the hedged item in a cash flow hedge.

B6.5.3 A hedge of a firm commitment (for example, a hedge of the change in fuel price

relating to an unrecognised contractual commitment by an electric utility to purchase

fuel at a fixed price) is a hedge of an exposure to a change in fair value. Accordingly,

such a hedge is a fair value hedge. However, in accordance with paragraph 6.5.4, a

hedge of the foreign currency risk of a firm commitment could alternatively be

accounted for as a cash flow hedge.

Measurement of hedge ineffectiveness

B6.5.4 When measuring hedge ineffectiveness, an entity shall consider the time value of

money. Consequently, the entity determines the value of the hedged item on a present

value basis and therefore the change in the value of the hedged item also includes the

effect of the time value of money.

B6.5.5 To calculate the change in the value of the hedged item for the purpose of measuring

hedge ineffectiveness, an entity may use a derivative that would have terms that

match the critical terms of the hedged item (this is commonly referred to as a

‘hypothetical derivative’), and, for example for a hedge of a forecast transaction,

would be calibrated using the hedged price (or rate) level. For example, if the hedge

was for a two-sided risk at the current market level, the hypothetical derivative would

represent a hypothetical forward contract that is calibrated to a value of nil at the time

of designation of the hedging relationship. If the hedge was for example for a one-

sided risk, the hypothetical derivative would represent the intrinsic value of a

hypothetical option that at the time of designation of the hedging relationship is at the

money if the hedged price level is the current market level, or out of the money if the

hedged price level is above (or, for a hedge of a long position, below) the current

market level. Using a hypothetical derivative is one possible way of calculating the

change in the value of the hedged item. The hypothetical derivative replicates the

hedged item and hence results in the same outcome as if that change in value was

determined by a different approach. Hence, using a ‘hypothetical derivative’ is not a

method in its own right but a mathematical expedient that can only be used to

calculate the value of the hedged item. Consequently, a ‘hypothetical derivative’

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cannot be used to include features in the value of the hedged item that only exist in

the hedging instrument (but not in the hedged item). An example is debt denominated

in a foreign currency (irrespective of whether it is fixed-rate or variable-rate debt).

When using a hypothetical derivative to calculate the change in the value of such

debt or the present value of the cumulative change in its cash flows, the hypothetical

derivative cannot simply impute a charge for exchanging different currencies even

though actual derivatives under which different currencies are exchanged might

include such a charge (for example, cross-currency interest rate swaps).

B6.5.6 The change in the value of the hedged item determined using a hypothetical

derivative may also be used for the purpose of assessing whether a hedging

relationship meets the hedge effectiveness requirements.

Rebalancing the hedging relationship and changes to the hedge ratio

B6.5.7 Rebalancing refers to the adjustments made to the designated quantities of the hedged

item or the hedging instrument of an already existing hedging relationship for the

purpose of maintaining a hedge ratio that complies with the hedge effectiveness

requirements. Changes to designated quantities of a hedged item or of a hedging

instrument for a different purpose do not constitute rebalancing for the purpose of

this Standard.

B6.5.8 Rebalancing is accounted for as a continuation of the hedging relationship in

accordance with paragraphs B6.5.9–B6.5.21. On rebalancing, the hedge

ineffectiveness of the hedging relationship is determined and recognised immediately

before adjusting the hedging relationship.

B6.5.9 Adjusting the hedge ratio allows an entity to respond to changes in the relationship

between the hedging instrument and the hedged item that arise from their underlyings

or risk variables. For example, a hedging relationship in which the hedging

instrument and the hedged item have different but related underlyings changes in

response to a change in the relationship between those two underlyings (for example,

different but related reference indices, rates or prices). Hence, rebalancing allows the

continuation of a hedging relationship in situations in which the relationship between

the hedging instrument and the hedged item changes in a way that can be

compensated for by adjusting the hedge ratio.

B6.5.10For example, an entity hedges an exposure to Foreign Currency A using a currency

derivative that references Foreign Currency B and Foreign Currencies A and B are

pegged (ie their exchange rate is maintained within a band or at an exchange rate set

by a central bank or other authority). If the exchange rate between Foreign Currency

A and Foreign Currency B were changed (ie a new band or rate was set), rebalancing

the hedging relationship to reflect the new exchange rate would ensure that the

hedging relationship would continue to meet the hedge effectiveness requirement for

the hedge ratio in the new circumstances. In contrast, if there was a default on the

currency derivative, changing the hedge ratio could not ensure that the hedging

relationship would continue to meet that hedge effectiveness requirement. Hence,

rebalancing does not facilitate the continuation of a hedging relationship in situations

in which the relationship between the hedging instrument and the hedged item

changes in a way that cannot be compensated for by adjusting the hedge ratio.

B6.5.11 Not every change in the extent of offset between the changes in the fair value of the

hedging instrument and the hedged item’s fair value or cash flows constitutes a

change in the relationship between the hedging instrument and the hedged item. An

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entity analyses the sources of hedge ineffectiveness that it expected to affect the

hedging relationship during its term and evaluates whether changes in the extent of

offset are:

(a) fluctuations around the hedge ratio, which remains valid (ie continues to

appropriately reflect the relationship between the hedging instrument and the

hedged item); or

(b) an indication that the hedge ratio no longer appropriately reflects the

relationship between the hedging instrument and the hedged item.

An entity performs this evaluation against the hedge effectiveness requirement for the

hedge ratio, ie to ensure that the hedging relationship does not reflect an imbalance

between the weightings of the hedged item and the hedging instrument that would

create hedge ineffectiveness (irrespective of whether recognised or not) that could

result in an accounting outcome that would be inconsistent with the purpose of hedge

accounting. Hence, this evaluation requires judgement.

B6.5.12Fluctuation around a constant hedge ratio (and hence the related hedge

ineffectiveness) cannot be reduced by adjusting the hedge ratio in response to each

particular outcome. Hence, in such circumstances, the change in the extent of offset

is a matter of measuring and recognising hedge ineffectiveness but does not require

rebalancing.

B6.5.13Conversely, if changes in the extent of offset indicate that the fluctuation is around a

hedge ratio that is different from the hedge ratio that is currently used for that

hedging relationship, or that there is a trend leading away from that hedge ratio,

hedge ineffectiveness can be reduced by adjusting the hedge ratio, whereas retaining

the hedge ratio would increasingly produce hedge ineffectiveness. Hence, in such

circumstances, an entity must evaluate whether the hedging relationship reflects an

imbalance between the weightings of the hedged item and the hedging instrument

that would create hedge ineffectiveness (irrespective of whether recognised or not)

that could result in an accounting outcome that would be inconsistent with the

purpose of hedge accounting. If the hedge ratio is adjusted, it also affects the

measurement and recognition of hedge ineffectiveness because, on rebalancing, the

hedge ineffectiveness of the hedging relationship must be determined and recognised

immediately before adjusting the hedging relationship in accordance with paragraph

B6.5.8.

B6.5.14Rebalancing means that, for hedge accounting purposes, after the start of a hedging

relationship an entity adjusts the quantities of the hedging instrument or the hedged

item in response to changes in circumstances that affect the hedge ratio of that

hedging relationship. Typically, that adjustment should reflect adjustments in the

quantities of the hedging instrument and the hedged item that it actually uses.

However, an entity must adjust the hedge ratio that results from the quantities of the

hedged item or the hedging instrument that it actually uses if:

(a) the hedge ratio that results from changes to the quantities of the hedging

instrument or the hedged item that the entity actually uses would reflect an

imbalance that would create hedge ineffectiveness that could result in an

accounting outcome that would be inconsistent with the purpose of hedge

accounting; or

(b) an entity would retain quantities of the hedging instrument and the hedged

item that it actually uses, resulting in a hedge ratio that, in new

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circumstances, would reflect an imbalance that would create hedge

ineffectiveness that could result in an accounting outcome that would be

inconsistent with the purpose of hedge accounting (ie an entity must not

create an imbalance by omitting to adjust the hedge ratio).

B6.5.15Rebalancing does not apply if the risk management objective for a hedging

relationship has changed. Instead, hedge accounting for that hedging relationship

shall be discontinued (despite that an entity might designate a new hedging

relationship that involves the hedging instrument or hedged item of the previous

hedging relationship as described in paragraph B6.5.28).

B6.5.16If a hedging relationship is rebalanced, the adjustment to the hedge ratio can be

effected in different ways:

(a) the weighting of the hedged item can be increased (which at the same time

reduces the weighting of the hedging instrument) by:

(i) increasing the volume of the hedged item; or

(ii) decreasing the volume of the hedging instrument.

(b) the weighting of the hedging instrument can be increased (which at the same

time reduces the weighting of the hedged item) by:

(i) increasing the volume of the hedging instrument; or

(ii) decreasing the volume of the hedged item.

Changes in volume refer to the quantities that are part of the hedging relationship.

Hence, decreases in volumes do not necessarily mean that the items or transactions

no longer exist, or are no longer expected to occur, but that they are not part of the

hedging relationship. For example, decreasing the volume of the hedging instrument

can result in the entity retaining a derivative, but only part of it might remain a

hedging instrument of the hedging relationship. This could occur if the rebalancing

could be effected only by reducing the volume of the hedging instrument in the

hedging relationship, but with the entity retaining the volume that is no longer

needed. In that case, the undesignated part of the derivative would be accounted for

at fair value through profit or loss (unless it was designated as a hedging instrument

in a different hedging relationship).

B6.5.17Adjusting the hedge ratio by increasing the volume of the hedged item does not affect

how the changes in the fair value of the hedging instrument are measured. The

measurement of the changes in the value of the hedged item related to the previously

designated volume also remains unaffected. However, from the date of rebalancing,

the changes in the value of the hedged item also include the change in the value of

the additional volume of the hedged item. These changes are measured starting from,

and by reference to, the date of rebalancing instead of the date on which the hedging

relationship was designated. For example, if an entity originally hedged a volume of

100 tonnes of a commodity at a forward price of CU80 (the forward price at

inception of the hedging relationship) and added a volume of 10 tonnes on

rebalancing when the forward price was CU90, the hedged item after rebalancing

would comprise two layers: 100 tonnes hedged at CU80 and 10 tonnes hedged at

CU90.

B6.5.18Adjusting the hedge ratio by decreasing the volume of the hedging instrument does

not affect how the changes in the value of the hedged item are measured. The

measurement of the changes in the fair value of the hedging instrument related to the

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volume that continues to be designated also remains unaffected. However, from the

date of rebalancing, the volume by which the hedging instrument was decreased is no

longer part of the hedging relationship. For example, if an entity originally hedged

the price risk of a commodity using a derivative volume of 100 tonnes as the hedging

instrument and reduces that volume by 10 tonnes on rebalancing, a nominal amount

of 90 tonnes of the hedging instrument volume would remain (see paragraph B6.5.16

for the consequences for the derivative volume (ie the 10 tonnes) that is no longer a

part of the hedging relationship).

B6.5.19Adjusting the hedge ratio by increasing the volume of the hedging instrument does

not affect how the changes in the value of the hedged item are measured. The

measurement of the changes in the fair value of the hedging instrument related to the

previously designated volume also remains unaffected. However, from the date of

rebalancing, the changes in the fair value of the hedging instrument also include the

changes in the value of the additional volume of the hedging instrument. The changes

are measured starting from, and by reference to, the date of rebalancing instead of the

date on which the hedging relationship was designated. For example, if an entity

originally hedged the price risk of a commodity using a derivative volume of 100

tonnes as the hedging instrument and added a volume of 10 tonnes on rebalancing,

the hedging instrument after rebalancing would comprise a total derivative volume of

110 tonnes. The change in the fair value of the hedging instrument is the total change

in the fair value of the derivatives that make up the total volume of 110 tonnes. These

derivatives could (and probably would) have different critical terms, such as their

forward rates, because they were entered into at different points in time (including

the possibility of designating derivatives into hedging relationships after their initial

recognition).

B6.5.20Adjusting the hedge ratio by decreasing the volume of the hedged item does not

affect how the changes in the fair value of the hedging instrument are measured. The

measurement of the changes in the value of the hedged item related to the volume

that continues to be designated also remains unaffected. However, from the date of

rebalancing, the volume by which the hedged item was decreased is no longer part of

the hedging relationship. For example, if an entity originally hedged a volume of 100

tonnes of a commodity at a forward price of CU80 and reduces that volume by 10

tonnes on rebalancing, the hedged item after rebalancing would be 90 tonnes hedged

at CU80. The 10 tonnes of the hedged item that are no longer part of the hedging

relationship would be accounted for in accordance with the requirements for the

discontinuation of hedge accounting (see paragraphs 6.5.6–6.5.7 and B6.5.22–

B6.5.28).

B6.5.21When rebalancing a hedging relationship, an entity shall update its analysis of the

sources of hedge ineffectiveness that are expected to affect the hedging relationship

during its (remaining) term (see paragraph B6.4.2). The documentation of the

hedging relationship shall be updated accordingly.

Discontinuation of hedge accounting

B6.5.22Discontinuation of hedge accounting applies prospectively from the date on which

the qualifying criteria are no longer met.

B6.5.23An entity shall not de-designate and thereby discontinue a hedging relationship that:

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(a) still meets the risk management objective on the basis of which it qualified

for hedge accounting (ie the entity still pursues that risk management

objective); and

(b) continues to meet all other qualifying criteria (after taking into account any

rebalancing of the hedging relationship, if applicable).

B6.5.24For the purposes of this Standard, an entity’s risk management strategy is

distinguished from its risk management objectives. The risk management strategy is

established at the highest level at which an entity determines how it manages its risk.

Risk management strategies typically identify the risks to which the entity is exposed

and set out how the entity responds to them. A risk management strategy is typically

in place for a longer period and may include some flexibility to react to changes in

circumstances that occur while that strategy is in place (for example, different interest

rate or commodity price levels that result in a different extent of hedging). This is

normally set out in a general document that is cascaded down through an entity

through policies containing more specific guidelines. In contrast, the risk

management objective for a hedging relationship applies at the level of a particular

hedging relationship. It relates to how the particular hedging instrument that has been

designated is used to hedge the particular exposure that has been designated as the

hedged item. Hence, a risk management strategy can involve many different hedging

relationships whose risk management objectives relate to executing that overall risk

management strategy. For example:

(a) an entity has a strategy of managing its interest rate exposure on debt funding

that sets ranges for the overall entity for the mix between variable-rate and

fixed-rate funding. The strategy is to maintain between 20 per cent and 40

per cent of the debt at fixed rates. The entity decides from time to time how

to execute this strategy (ie where it positions itself within the 20 per cent to

40 per cent range for fixed-rate interest exposure) depending on the level of

interest rates. If interest rates are low the entity fixes the interest for more

debt than when interest rates are high. The entity’s debt is CU100 of variable-

rate debt of which CU30 is swapped into a fixed-rate exposure. The entity

takes advantage of low interest rates to issue an additional CU50 of debt to

finance a major investment, which the entity does by issuing a fixed-rate

bond. In the light of the low interest rates, the entity decides to set its fixed

interest-rate exposure to 40 per cent of the total debt by reducing by CU20

the extent to which it previously hedged its variable-rate exposure, resulting

in CU60 of fixed-rate exposure. In this situation the risk management

strategy itself remains unchanged. However, in contrast the entity’s execution

of that strategy has changed and this means that, for CU20 of variable-rate

exposure that was previously hedged, the risk management objective has

changed (ie at the hedging relationship level). Consequently, in this situation

hedge accounting must be discontinued for CU20 of the previously hedged

variable-rate exposure. This could involve reducing the swap position by a

CU20 nominal amount but, depending on the circumstances, an entity might

retain that swap volume and, for example, use it for hedging a different

exposure or it might become part of a trading book. Conversely, if an entity

instead swapped a part of its new fixed-rate debt into a variable-rate

exposure, hedge accounting would have to be continued for its previously

hedged variable-rate exposure.

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(b) some exposures result from positions that frequently change, for example,

the interest rate risk of an open portfolio of debt instruments. The addition of

new debt instruments and the derecognition of debt instruments continuously

change that exposure (ie it is different from simply running off a position that

matures). This is a dynamic process in which both the exposure and the

hedging instruments used to manage it do not remain the same for long.

Consequently, an entity with such an exposure frequently adjusts the hedging

instruments used to manage the interest rate risk as the exposure changes. For

example, debt instruments with 24 months’ remaining maturity are

designated as the hedged item for interest rate risk for 24 months. The same

procedure is applied to other time buckets or maturity periods. After a short

period of time, the entity discontinues all, some or a part of the previously

designated hedging relationships for maturity periods and designates new

hedging relationships for maturity periods on the basis of their size and the

hedging instruments that exist at that time. The discontinuation of hedge

accounting in this situation reflects that those hedging relationships are

established in such a way that the entity looks at a new hedging instrument

and a new hedged item instead of the hedging instrument and the hedged

item that were designated previously. The risk management strategy remains

the same, but there is no risk management objective that continues for those

previously designated hedging relationships, which as such no longer exist.

In such a situation, the discontinuation of hedge accounting applies to the

extent to which the risk management objective has changed. This depends on

the situation of an entity and could, for example, affect all or only some

hedging relationships of a maturity period, or only part of a hedging

relationship.

(c) an entity has a risk management strategy whereby it manages the foreign

currency risk of forecast sales and the resulting receivables. Within that

strategy the entity manages the foreign currency risk as a particular hedging

relationship only up to the point of the recognition of the receivable.

Thereafter, the entity no longer manages the foreign currency risk on the

basis of that particular hedging relationship. Instead, it manages together the

foreign currency risk from receivables, payables and derivatives (that do not

relate to forecast transactions that are still pending) denominated in the same

foreign currency. For accounting purposes, this works as a ‘natural’ hedge

because the gains and losses from the foreign currency risk on all of those

items are immediately recognised in profit or loss. Consequently, for

accounting purposes, if the hedging relationship is designated for the period

up to the payment date, it must be discontinued when the receivable is

recognised, because the risk management objective of the original hedging

relationship no longer applies. The foreign currency risk is now managed

within the same strategy but on a different basis. Conversely, if an entity had

a different risk management objective and managed the foreign currency risk

as one continuous hedging relationship specifically for that forecast sales

amount and the resulting receivable until the settlement date, hedge

accounting would continue until that date.

B6.5.25The discontinuation of hedge accounting can affect:

(a) a hedging relationship in its entirety; or

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(b) a part of a hedging relationship (which means that hedge accounting

continues for the remainder of the hedging relationship).

B6.5.26A hedging relationship is discontinued in its entirety when, as a whole, it ceases to

meet the qualifying criteria. For example:

(a) the hedging relationship no longer meets the risk management objective on

the basis of which it qualified for hedge accounting (ie the entity no longer

pursues that risk management objective);

(b) the hedging instrument or instruments have been sold or terminated (in

relation to the entire volume that was part of the hedging relationship); or

(c) there is no longer an economic relationship between the hedged item and the

hedging instrument or the effect of credit risk starts to dominate the value

changes that result from that economic relationship.

B6.5.27A part of a hedging relationship is discontinued (and hedge accounting continues for

its remainder) when only a part of the hedging relationship ceases to meet the

qualifying criteria. For example:

(a) on rebalancing of the hedging relationship, the hedge ratio might be adjusted

in such a way that some of the volume of the hedged item is no longer part of

the hedging relationship (see paragraph B6.5.20); hence, hedge accounting is

discontinued only for the volume of the hedged item that is no longer part of

the hedging relationship; or

(b) when the occurrence of some of the volume of the hedged item that is (or is a

component of) a forecast transaction is no longer highly probable, hedge

accounting is discontinued only for the volume of the hedged item whose

occurrence is no longer highly probable. However, if an entity has a history

of having designated hedges of forecast transactions and having subsequently

determined that the forecast transactions are no longer expected to occur, the

entity’s ability to predict forecast transactions accurately is called into

question when predicting similar forecast transactions. This affects the

assessment of whether similar forecast transactions are highly probable (see

paragraph 6.3.3) and hence whether they are eligible as hedged items.

B6.5.28An entity can designate a new hedging relationship that involves the hedging

instrument or hedged item of a previous hedging relationship for which hedge

accounting was (in part or in its entirety) discontinued. This does not constitute a

continuation of a hedging relationship but is a restart. For example:

(a) a hedging instrument experiences such a severe credit deterioration that the

entity replaces it with a new hedging instrument. This means that the original

hedging relationship failed to achieve the risk management objective and is

hence discontinued in its entirety. The new hedging instrument is designated

as the hedge of the same exposure that was hedged previously and forms a

new hedging relationship. Hence, the changes in the fair value or the cash

flows of the hedged item are measured starting from, and by reference to, the

date of designation of the new hedging relationship instead of the date on

which the original hedging relationship was designated.

(b) a hedging relationship is discontinued before the end of its term. The hedging

instrument in that hedging relationship can be designated as the hedging

instrument in another hedging relationship (for example, when adjusting the

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hedge ratio on rebalancing by increasing the volume of the hedging

instrument or when designating a whole new hedging relationship).

Accounting for the time value of options

B6.5.29An option can be considered as being related to a time period because its time value

represents a charge for providing protection for the option holder over a period of

time. However, the relevant aspect for the purpose of assessing whether an option

hedges a transaction or time-period related hedged item are the characteristics of that

hedged item, including how and when it affects profit or loss. Hence, an entity shall

assess the type of hedged item (see paragraph 6.5.15(a)) on the basis of the nature of

the hedged item (regardless of whether the hedging relationship is a cash flow hedge

or a fair value hedge):

(a) the time value of an option relates to a transaction related hedged item if the

nature of the hedged item is a transaction for which the time value has the

character of costs of that transaction. An example is when the time value of

an option relates to a hedged item that results in the recognition of an item

whose initial measurement includes transaction costs (for example, an entity

hedges a commodity purchase, whether it is a forecast transaction or a firm

commitment, against the commodity price risk and includes the transaction

costs in the initial measurement of the inventory). As a consequence of

including the time value of the option in the initial measurement of the

particular hedged item, the time value affects profit or loss at the same time

as that hedged item. Similarly, an entity that hedges a sale of a commodity,

whether it is a forecast transaction or a firm commitment, would include the

time value of the option as part of the cost related to that sale (hence, the time

value would be recognised in profit or loss in the same period as the revenue

from the hedged sale).

(b) the time value of an option relates to a time-period related hedged item if the

nature of the hedged item is such that the time value has the character of a

cost for obtaining protection against a risk over a particular period of time

(but the hedged item does not result in a transaction that involves the notion

of a transaction cost in accordance with (a)). For example, if commodity

inventory is hedged against a fair value decrease for six months using a

commodity option with a corresponding life, the time value of the option

would be allocated to profit or loss (ie amortised on a systematic and rational

basis) over that six-month period. Another example is a hedge of a net

investment in a foreign operation that is hedged for 18 months using a

foreign-exchange option, which would result in allocating the time value of

the option over that 18-month period.

B6.5.30The characteristics of the hedged item, including how and when the hedged item

affects profit or loss, also affect the period over which the time value of an option

that hedges a time-period related hedged item is amortised, which is consistent with

the period over which the option’s intrinsic value can affect profit or loss in

accordance with hedge accounting. For example, if an interest rate option (a cap) is

used to provide protection against increases in the interest expense on a floating rate

bond, the time value of that cap is amortised to profit or loss over the same period

over which any intrinsic value of the cap would affect profit or loss:

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(a) if the cap hedges increases in interest rates for the first three years out of a

total life of the floating rate bond of five years, the time value of that cap is

amortised over the first three years; or

(b) if the cap is a forward start option that hedges increases in interest rates for

years two and three out of a total life of the floating rate bond of five years,

the time value of that cap is amortised during years two and three.

B6.5.31The accounting for the time value of options in accordance with paragraph 6.5.15

also applies to a combination of a purchased and a written option (one being a put

option and one being a call option) that at the date of designation as a hedging

instrument has a net nil time value (commonly referred to as a ‘zero-cost collar’). In

that case, an entity shall recognise any changes in time value in other comprehensive

income, even though the cumulative change in time value over the total period of the

hedging relationship is nil. Hence, if the time value of the option relates to:

(a) a transaction related hedged item, the amount of time value at the end of the

hedging relationship that adjusts the hedged item or that is reclassified to

profit or loss (see paragraph 6.5.15(b)) would be nil.

(b) a time-period related hedged item, the amortisation expense related to the

time value is nil.

B6.5.32The accounting for the time value of options in accordance with paragraph 6.5.15

applies only to the extent that the time value relates to the hedged item (aligned time

value). The time value of an option relates to the hedged item if the critical terms of

the option (such as the nominal amount, life and underlying) are aligned with the

hedged item. Hence, if the critical terms of the option and the hedged item are not

fully aligned, an entity shall determine the aligned time value, ie how much of the

time value included in the premium (actual time value) relates to the hedged item

(and therefore should be treated in accordance with paragraph 6.5.15). An entity

determines the aligned time value using the valuation of the option that would have

critical terms that perfectly match the hedged item.

B6.5.33If the actual time value and the aligned time value differ, an entity shall determine the

amount that is accumulated in a separate component of equity in accordance with

paragraph 6.5.15 as follows:

(a) if, at inception of the hedging relationship, the actual time value is higher

than the aligned time value, the entity shall:

(i) determine the amount that is accumulated in a separate component of

equity on the basis of the aligned time value; and

(ii) account for the differences in the fair value changes between the two

time values in profit or loss.

(b) if, at inception of the hedging relationship, the actual time value is lower than

the aligned time value, the entity shall determine the amount that is

accumulated in a separate component of equity by reference to the lower of

the cumulative change in fair value of:

(i) the actual time value; and

(ii) the aligned time value.

Any remainder of the change in fair value of the actual time value shall be recognised

in profit or loss.

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Accounting for the forward element of forward contracts and foreign currency basis spreads of financial instruments

B6.5.34A forward contract can be considered as being related to a time period because its

forward element represents charges for a period of time (which is the tenor for which

it is determined). However, the relevant aspect for the purpose of assessing whether a

hedging instrument hedges a transaction or time-period related hedged item are the

characteristics of that hedged item, including how and when it affects profit or loss.

Hence, an entity shall assess the type of hedged item (see paragraphs 6.5.16 and

6.5.15(a)) on the basis of the nature of the hedged item (regardless of whether the

hedging relationship is a cash flow hedge or a fair value hedge):

(a) the forward element of a forward contract relates to a transaction related

hedged item if the nature of the hedged item is a transaction for which the

forward element has the character of costs of that transaction. An example is

when the forward element relates to a hedged item that results in the

recognition of an item whose initial measurement includes transaction costs

(for example, an entity hedges an inventory purchase denominated in a

foreign currency, whether it is a forecast transaction or a firm commitment,

against foreign currency risk and includes the transaction costs in the initial

measurement of the inventory). As a consequence of including the forward

element in the initial measurement of the particular hedged item, the forward

element affects profit or loss at the same time as that hedged item. Similarly,

an entity that hedges a sale of a commodity denominated in a foreign

currency against foreign currency risk, whether it is a forecast transaction or

a firm commitment, would include the forward element as part of the cost

that is related to that sale (hence, the forward element would be recognised in

profit or loss in the same period as the revenue from the hedged sale).

(b) the forward element of a forward contract relates to a time-period related

hedged item if the nature of the hedged item is such that the forward element

has the character of a cost for obtaining protection against a risk over a

particular period of time (but the hedged item does not result in a transaction

that involves the notion of a transaction cost in accordance with (a)). For

example, if commodity inventory is hedged against changes in fair value for

six months using a commodity forward contract with a corresponding life,

the forward element of the forward contract would be allocated to profit or

loss (ie amortised on a systematic and rational basis) over that six-month

period. Another example is a hedge of a net investment in a foreign operation

that is hedged for 18 months using a foreign-exchange forward contract,

which would result in allocating the forward element of the forward contract

over that 18-month period.

B6.5.35The characteristics of the hedged item, including how and when the hedged item

affects profit or loss, also affect the period over which the forward element of a

forward contract that hedges a time-period related hedged item is amortised, which is

over the period to which the forward element relates. For example, if a forward

contract hedges the exposure to variability in three-month interest rates for a three-

month period that starts in six months’ time, the forward element is amortised during

the period that spans months seven to nine.

B6.5.36The accounting for the forward element of a forward contract in accordance with

paragraph 6.5.16 also applies if, at the date on which the forward contract is

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designated as a hedging instrument, the forward element is nil. In that case, an entity

shall recognise any fair value changes attributable to the forward element in other

comprehensive income, even though the cumulative fair value change attributable to

the forward element over the total period of the hedging relationship is nil. Hence, if

the forward element of a forward contract relates to:

(a) a transaction related hedged item, the amount in respect of the forward

element at the end of the hedging relationship that adjusts the hedged item or

that is reclassified to profit or loss (see paragraphs 6.5.15(b) and 6.5.16)

would be nil.

(b) a time-period related hedged item, the amortisation amount related to the

forward element is nil.

B6.5.37The accounting for the forward element of forward contracts in accordance with

paragraph 6.5.16 applies only to the extent that the forward element relates to the

hedged item (aligned forward element). The forward element of a forward contract

relates to the hedged item if the critical terms of the forward contract (such as the

nominal amount, life and underlying) are aligned with the hedged item. Hence, if the

critical terms of the forward contract and the hedged item are not fully aligned, an

entity shall determine the aligned forward element, ie how much of the forward

element included in the forward contract (actual forward element) relates to the

hedged item (and therefore should be treated in accordance with paragraph 6.5.16).

An entity determines the aligned forward element using the valuation of the forward

contract that would have critical terms that perfectly match the hedged item.

B6.5.38If the actual forward element and the aligned forward element differ, an entity shall

determine the amount that is accumulated in a separate component of equity in

accordance with paragraph 6.5.16 as follows:

(a) if, at inception of the hedging relationship, the absolute amount of the actual

forward element is higher than that of the aligned forward element the entity

shall:

(i) determine the amount that is accumulated in a separate component of

equity on the basis of the aligned forward element; and

(ii) account for the differences in the fair value changes between the two

forward elements in profit or loss.

(b) if, at inception of the hedging relationship, the absolute amount of the actual

forward element is lower than that of the aligned forward element, the entity

shall determine the amount that is accumulated in a separate component of

equity by reference to the lower of the cumulative change in fair value of:

(i) the absolute amount of the actual forward element; and

(ii) the absolute amount of the aligned forward element.

Any remainder of the change in fair value of the actual forward element shall be


B6.5.39When an entity separates the foreign currency basis spread from a financial

instrument and excludes it from the designation of that financial instrument as the

hedging instrument (see paragraph 6.2.4(b)), the application guidance in paragraphs

B6.5.34–B6.5.38 applies to the foreign currency basis spread in the same manner as

it is applied to the forward element of a forward contract.

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Hedge of a group of items (Section 6.6)

Hedge of a net position

Eligibility for hedge accounting and designation of a net position

B6.6.1 A net position is eligible for hedge accounting only if an entity hedges on a net basis

for risk management purposes. Whether an entity hedges in this way is a matter of

fact (not merely of assertion or documentation). Hence, an entity cannot apply hedge

accounting on a net basis solely to achieve a particular accounting outcome if that

would not reflect its risk management approach. Net position hedging must form part

of an established risk management strategy. Normally this would be approved by key

management personnel as defined in NAS 24.

B6.6.2 For example, Entity A, whose functional currency is its local currency, has a firm

commitment to pay FC150,000 for advertising expenses in nine months’ time and a

firm commitment to sell finished goods for FC150,000 in 15 months’ time. Entity A

enters into a foreign currency derivative that settles in nine months’ time under which

it receives FC100 and pays CU70. Entity A has no other exposures to FC. Entity A

does not manage foreign currency risk on a net basis. Hence, Entity A cannot apply

hedge accounting for a hedging relationship between the foreign currency derivative

and a net position of FC100 (consisting of FC150,000 of the firm purchase

commitment—ie advertising services—and FC149,900 (of the FC150,000) of the

firm sale commitment) for a nine-month period.

B6.6.3 If Entity A did manage foreign currency risk on a net basis and did not enter into the

foreign currency derivative (because it increases its foreign currency risk exposure

instead of reducing it), then the entity would be in a natural hedged position for nine

months. Normally, this hedged position would not be reflected in the financial

statements because the transactions are recognised in different reporting periods in

the future. The nil net position would be eligible for hedge accounting only if the

conditions in paragraph 6.6.6 are met.

B6.6.4 When a group of items that constitute a net position is designated as a hedged item,

an entity shall designate the overall group of items that includes the items that can

make up the net position. An entity is not permitted to designate a non-specific

abstract amount of a net position. For example, an entity has a group of firm sale

commitments in nine months’ time for FC100 and a group of firm purchase

commitments in 18 months’ time for FC120. The entity cannot designate an abstract

amount of a net position up to FC20. Instead, it must designate a gross amount of

purchases and a gross amount of sales that together give rise to the hedged net

position. An entity shall designate gross positions that give rise to the net position so

that the entity is able to comply with the requirements for the accounting for

qualifying hedging relationships.

Application of the hedge effectiveness requirements to a hedge of a net position

B6.6.5 When an entity determines whether the hedge effectiveness requirements of

paragraph 6.4.1(c) are met when it hedges a net position, it shall consider the changes

in the value of the items in the net position that have a similar effect as the hedging

instrument in conjunction with the fair value change on the hedging instrument. For

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example, an entity has a group of firm sale commitments in nine months’ time for

FC100 and a group of firm purchase commitments in 18 months’ time for FC120. It

hedges the foreign currency risk of the net position of FC20 using a forward

exchange contract for FC20. When determining whether the hedge effectiveness

requirements of paragraph 6.4.1(c) are met, the entity shall consider the relationship

between:

(a) the fair value change on the forward exchange contract together with the

foreign currency risk related changes in the value of the firm sale

commitments; and

(b) the foreign currency risk related changes in the value of the firm purchase

commitments.

B6.6.6 Similarly, if in the example in paragraph B6.6.5 the entity had a nil net position it

would consider the relationship between the foreign currency risk related changes in

the value of the firm sale commitments and the foreign currency risk related changes

in the value of the firm purchase commitments when determining whether the hedge

effectiveness requirements of paragraph 6.4.1(c) are met.

Cash flow hedges that constitute a net position

B6.6.7 When an entity hedges a group of items with offsetting risk positions (ie a net

position), the eligibility for hedge accounting depends on the type of hedge. If the

hedge is a fair value hedge, then the net position may be eligible as a hedged item. If,

however, the hedge is a cash flow hedge, then the net position can only be eligible as

a hedged item if it is a hedge of foreign currency risk and the designation of that net

position specifies the reporting period in which the forecast transactions are expected

to affect profit or loss and also specifies their nature and volume.

B6.6.8 For example, an entity has a net position that consists of a bottom layer of FC100 of

sales and a bottom layer of FC150 of purchases. Both sales and purchases are

denominated in the same foreign currency. In order to sufficiently specify the

designation of the hedged net position, the entity specifies in the original

documentation of the hedging relationship that sales can be of Product A or Product

B and purchases can be of Machinery Type A, Machinery Type B and Raw Material

A. The entity also specifies the volumes of the transactions by each nature. The entity

documents that the bottom layer of sales (FC100) is made up of a forecast sales

volume of the first FC70 of Product A and the first FC30 of Product B. If those sales

volumes are expected to affect profit or loss in different reporting periods, the entity

would include that in the documentation, for example, the first FC70 from sales of

Product A that are expected to affect profit or loss in the first reporting period and the

first FC30 from sales of Product B that are expected to affect profit or loss in the

second reporting period. The entity also documents that the bottom layer of the

purchases (FC150) is made up of purchases of the first FC60 of Machinery Type A,

the first FC40 of Machinery Type B and the first FC50 of Raw Material A. If those

purchase volumes are expected to affect profit or loss in different reporting periods,

the entity would include in the documentation a disaggregation of the purchase

volumes by the reporting periods in which they are expected to affect profit or loss

(similarly to how it documents the sales volumes). For example, the forecast

transaction would be specified as:

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(a) the first FC60 of purchases of Machinery Type A that are expected to affect

profit or loss from the third reporting period over the next ten reporting

periods;

(b) the first FC40 of purchases of Machinery Type B that are expected to affect

profit or loss from the fourth reporting period over the next 20 reporting

periods; and

(c) the first FC50 of purchases of Raw Material A that are expected to be

received in the third reporting period and sold, ie affect profit or loss, in that

and the next reporting period.

Specifying the nature of the forecast transaction volumes would include aspects such

as the depreciation pattern for items of property, plant and equipment of the same

kind, if the nature of those items is such that the depreciation pattern could vary

depending on how the entity uses those items. For example, if the entity uses items of

Machinery Type A in two different production processes that result in straight-line

depreciation over ten reporting periods and the units of production method

respectively, its documentation of the forecast purchase volume for Machinery Type

A would disaggregate that volume by which of those depreciation patterns will apply.

B6.6.9 For a cash flow hedge of a net position, the amounts determined in accordance with

paragraph 6.5.11 shall include the changes in the value of the items in the net position

that have a similar effect as the hedging instrument in conjunction with the fair value

change on the hedging instrument. However, the changes in the value of the items in

the net position that have a similar effect as the hedging instrument are recognised

only once the transactions that they relate to are recognised, such as when a forecast

sale is recognised as revenue. For example, an entity has a group of highly probable

forecast sales in nine months’ time for FC100 and a group of highly probable forecast

purchases in 18 months’ time for FC120. It hedges the foreign currency risk of the

net position of FC20 using a forward exchange contract for FC20. When determining

the amounts that are recognised in the cash flow hedge reserve in accordance with

paragraph 6.5.11(a)–6.5.11(b), the entity compares:

(a) the fair value change on the forward exchange contract together with the

foreign currency risk related changes in the value of the highly probable

forecast sales; with

(b) the foreign currency risk related changes in the value of the highly probable

forecast purchases.

However, the entity recognises only amounts related to the forward exchange

contract until the highly probable forecast sales transactions are recognised in the

financial statements, at which time the gains or losses on those forecast transactions

are recognised (ie the change in the value attributable to the change in the foreign

exchange rate between the designation of the hedging relationship and the

recognition of revenue).

B6.6.10Similarly, if in the example the entity had a nil net position it would compare the

foreign currency risk related changes in the value of the highly probable forecast

sales with the foreign currency risk related changes in the value of the highly

probable forecast purchases. However, those amounts are recognised only once the

related forecast transactions are recognised in the financial statements.

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Layers of groups of items designated as the hedged item

B6.6.11 For the same reasons noted in paragraph B6.3.19, designating layer components of

groups of existing items requires the specific identification of the nominal amount of

the group of items from which the hedged layer component is defined.

B6.6.12A hedging relationship can include layers from several different groups of items. For

example, in a hedge of a net position of a group of assets and a group of liabilities,

the hedging relationship can comprise, in combination, a layer component of the

group of assets and a layer component of the group of liabilities.

Presentation of hedging instrument gains or losses

B6.6.13If items are hedged together as a group in a cash flow hedge, they might affect

different line items in the statement of profit or loss and other comprehensive

income. The presentation of hedging gains or losses in that statement depends on the

group of items.

B6.6.14If the group of items does not have any offsetting risk positions (for example, a group

of foreign currency expenses that affect different line items in the statement of profit

or loss and other comprehensive income that are hedged for foreign currency risk)

then the reclassified hedging instrument gains or losses shall be apportioned to the

line items affected by the hedged items. This apportionment shall be done on a

systematic and rational basis and shall not result in the grossing up of the net gains or

losses arising from a single hedging instrument.

B6.6.15If the group of items does have offsetting risk positions (for example, a group of sales

and expenses denominated in a foreign currency hedged together for foreign currency

risk) then an entity shall present the hedging gains or losses in a separate line item in

the statement of profit or loss and other comprehensive income. Consider, for

example, a hedge of the foreign currency risk of a net position of foreign currency

sales of FC100 and foreign currency expenses of FC80 using a forward exchange

contract for FC20. The gain or loss on the forward exchange contract that is

reclassified from the cash flow hedge reserve to profit or loss (when the net position

affects profit or loss) shall be presented in a separate line item from the hedged sales

and expenses. Moreover, if the sales occur in an earlier period than the expenses, the

sales revenue is still measured at the spot exchange rate in accordance with NAS 21.

The related hedging gain or loss is presented in a separate line item, so that profit or

loss reflects the effect of hedging the net position, with a corresponding adjustment to

the cash flow hedge reserve. When the hedged expenses affect profit or loss in a later

period, the hedging gain or loss previously recognised in the cash flow hedge reserve

on the sales is reclassified to profit or loss and presented as a separate line item from

those that include the hedged expenses, which are measured at the spot exchange rate

in accordance with NAS 21.

B6.6.16For some types of fair value hedges, the objective of the hedge is not primarily to

offset the fair value change of the hedged item but instead to transform the cash flows

of the hedged item. For example, an entity hedges the fair value interest rate risk of a

fixed-rate debt instrument using an interest rate swap. The entity’s hedge objective is

to transform the fixed-interest cash flows into floating interest cash flows. This

objective is reflected in the accounting for the hedging relationship by accruing the

net interest accrual on the interest rate swap in profit or loss. In the case of a hedge of

a net position (for example, a net position of a fixed-rate asset and a fixed-rate

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liability), this net interest accrual must be presented in a separate line item in the

statement of profit or loss and other comprehensive income. This is to avoid the

grossing up of a single instrument’s net gains or losses into offsetting gross amounts

and recognising them in different line items (for example, this avoids grossing up a

net interest receipt on a single interest rate swap into gross interest revenue and gross

interest expense).

Effective date and transition (Chapter 7)

Transition (Section 7.2)

Financial assets held for trading

B7.2.1 At the date of initial application of this Standard, an entity must determine whether

the objective of the entity’s business model for managing any of its financial assets

meets the condition in paragraph 4.1.2(a) or the condition in paragraph 4.1.2A(a) or

if a financial asset is eligible for the election in paragraph 5.7.5. For that purpose, an

entity shall determine whether financial assets meet the definition of held for trading

as if the entity had purchased the assets at the date of initial application.

Impairment

B7.2.2 On transition, an entity should seek to approximate the credit risk on initial

recognition by considering all reasonable and supportable information that is

available without undue cost or effort. An entity is not required to undertake an

exhaustive search for information when determining, at the date of transition,

whether there have been significant increases in credit risk since initial recognition. If

an entity is unable to make this determination without undue cost or effort paragraph

7.2.20 applies.

B7.2.3 In order to determine the loss allowance on financial instruments initially recognised

(or loan commitments or financial guarantee contracts to which the entity became a

party to the contract) prior to the date of initial application, both on transition and

until the derecognition of those items an entity shall consider information that is

relevant in determining or approximating the credit risk at initial recognition. In order

to determine or approximate the initial credit risk, an entity may consider internal and

external information, including portfolio information, in accordance with paragraphs

B5.5.1–B5.5.6.

B7.2.4 An entity with little historical information may use information from internal reports

and statistics (that may have been generated when deciding whether to launch a new

product), information about similar products or peer group experience for comparable

financial instruments, if relevant.

Definitions (Appendix A)

Derivatives

BA.1 Typical examples of derivatives are futures and forward, swap and option contracts.

A derivative usually has a notional amount, which is an amount of currency, a

number of shares, a number of units of weight or volume or other units specified in

the contract. However, a derivative instrument does not require the holder or writer to

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invest or receive the notional amount at the inception of the contract. Alternatively, a

derivative could require a fixed payment or payment of an amount that can change

(but not proportionally with a change in the underlying) as a result of some future

event that is unrelated to a notional amount. For example, a contract may require a

fixed payment of CU1,000 if six-month LIBOR increases by 100 basis points. Such a

contract is a derivative even though a notional amount is not specified.

BA.2 The definition of a derivative in this Standard includes contracts that are settled gross

by delivery of the underlying item (eg a forward contract to purchase a fixed rate debt

instrument). An entity may have a contract to buy or sell a non-financial item that can

be settled net in cash or another financial instrument or by exchanging financial

instruments (eg a contract to buy or sell a commodity at a fixed price at a future

date). Such a contract is within the scope of this Standard unless it was entered into

and continues to be held for the purpose of delivery of a non-financial item in

accordance with the entity’s expected purchase, sale or usage requirements. However,

this Standard applies to such contracts for an entity’s expected purchase, sale or

usage requirements if the entity makes a designation in accordance with paragraph

2.5 (see paragraphs 2.4–2.7).

BA.3 One of the defining characteristics of a derivative is that it has an initial net

investment that is smaller than would be required for other types of contracts that

would be expected to have a similar response to changes in market factors. An option

contract meets that definition because the premium is less than the investment that

would be required to obtain the underlying financial instrument to which the option is

linked. A currency swap that requires an initial exchange of different currencies of

equal fair values meets the definition because it has a zero initial net investment.

BA.4 A regular way purchase or sale gives rise to a fixed price commitment between trade

date and settlement date that meets the definition of a derivative. However, because

of the short duration of the commitment it is not recognised as a derivative financial

instrument. Instead, this Standard provides for special accounting for such regular

way contracts (see paragraphs 3.1.2 and B3.1.3–B3.1.6).

BA.5 The definition of a derivative refers to non-financial variables that are not specific to

a party to the contract. These include an index of earthquake losses in a particular

region and an index of temperatures in a particular city. Non-financial variables

specific to a party to the contract include the occurrence or non-occurrence of a fire

that damages or destroys an asset of a party to the contract. A change in the fair value

of a non-financial asset is specific to the owner if the fair value reflects not only

changes in market prices for such assets (a financial variable) but also the condition

of the specific non-financial asset held (a non-financial variable). For example, if a

guarantee of the residual value of a specific car exposes the guarantor to the risk of

changes in the car’s physical condition, the change in that residual value is specific to

the owner of the car.

Financial assets and liabilities held for trading

BA.6 Trading generally reflects active and frequent buying and selling, and financial

instruments held for trading generally are used with the objective of generating a

profit from short-term fluctuations in price or dealer’s margin.

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BA.7 Financial liabilities held for trading include:

(a) derivative liabilities that are not accounted for as hedging instruments;

(b) obligations to deliver financial assets borrowed by a short seller (ie an entity

that sells financial assets it has borrowed and does not yet own);

(c) financial liabilities that are incurred with an intention to repurchase them in

the near term (eg a quoted debt instrument that the issuer may buy back in

the near term depending on changes in its fair value); and

(d) financial liabilities that are part of a portfolio of identified financial

instruments that are managed together and for which there is evidence of a

recent pattern of short-term profit-taking.

BA.8 The fact that a liability is used to fund trading activities does not in itself make that

liability one that is held for trading.

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